Overview: Revenue Options and Reforming the Tax Code

Comments for the Record

United States

Joint Select Committee on Deficit Reduction

Overview: Revenue Options and Reforming the Tax Code

Thursday, September 22 2011

By Michael Bindner

Center for Fiscal Equity

Chairwoman Murray and Vice Chairman Hensarling, thank you for the opportunity to address this topic. 

The Center for Fiscal Equity has a four part proposal for long term tax reform, which will be familiar to members and staff from the House Ways and Means and Senate Finance Committees who have read our comments over the last several months.  The key elements are

• a Value Added Tax (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.

A Value Added Tax can be adjusted at the border by exempting payment for exports and fully taxing imports.  The VAT can replace payment of low-rate income taxes, should be receipt visible for consumers and should be set aside to fund discretionary domestic military and civil spending.  The receipt visibility allows more informed decisions by those who advocate discretionary spending programs and the public at large.  Changes to trade policy implicit in enacting a VAT will more than offset any job losses caused by decreased discretionary spending – and the impact of tax increases is minimal if VAT enactment offsets a portion of income tax collections.

The NBRT base is similar to a Value Added Tax (VAT), but not identical. Unlike a VAT, an 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 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.

In the long term, the explosion of the debt comes from the aging of society and the funding of their health care costs.  Some thought should be given to ways to reverse a demographic imbalance that produces too few children while life expectancy of the elderly increases.

Unassisted labor markets work against population growth.  Given a choice between hiring parents with children and recent college graduates, the smart decision will always be to hire the new graduates, as they will demand less money – especially in the technology area where recent training is often valued over experience. 

Separating out pay for families allows society to reverse that trend, with a significant driver to that separation being a more generous tax credit for children.  Such a credit could be “paid for” by ending the Mortgage Interest Deduction (MID) without hurting the housing sector, as housing is the biggest area of cost growth when children are added.  While lobbyists for lenders and realtors would prefer gridlock on reducing the MID, if forced to chose between transferring this deduction to families and using it for deficit reduction (as both Bowles-Simpson and Rivlin-Domenici suggest), we suspect that they would chose the former over the latter if forced to make a choice.  The religious community could also see such a development as a “pro-life” vote, especially among religious liberals.

Enactment of such a credit meets both our nation’s short term needs for consumer liquidity and our long term need for population growth.  Adding this issue to the pro-life agenda, at least in some quarters, makes this proposal a win for everyone.

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.

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 NBRT 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.

The NBRT 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. This is a feature that is impossible with the FairTax or a VAT alone.

To extract cost savings under the NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit, provided that services are at least as generous as the current programs. 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 not so much that the free market is destroyed.

Enacting the NBRT 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 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.

In testimony before this 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 surtaxes on that income.

The Center 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.

Both the NBRT and VAT would, as consumption taxes, burden both labor costs and profit. In other OECD countries, all of whom have consumption taxes, capital gains taxes can be lower, since a portion of the taxation of capital already occurs as part of the VAT.  The logic to enact lower capital gains and dividend taxes outside of a consumption tax environment is not as strong.

The Center for Fiscal Equity believes that lower dividend, capital gains and marginal income taxes for the wealthy actually destroy more jobs than they create.  This occurs for a very simple reason – management and owners who receive lower tax rates have more an incentive to extract productivity gains from the work force through benefit cuts, lower wages, sending jobs offshore or automating work.  As taxes on management and owners go down, the marginal incentives for cost cutting go up.  As taxes go up, the marginal benefit for such savings go down.  It is no accident that the middle class began losing ground when taxes were cut during the Reagan and recent Bush Administrations, both of which saw huge tax cuts.  Keeping these taxes low is also part of why we are experiencing a jobless recovery now.

As long as management and ownership benefit personally from cutting jobs, they will continue to do so.  Tax reform must reverse these perverse incentives.

In order to preserve vertical equity in a given tax year in a consumption tax environment, some form of progressive income and inheritance taxation is essential, otherwise the debt crisis cannot be avoided as consumption taxes will never be adequate to replace the lost revenue. 

The Center suggests retaining surtaxes on high income earners and heirs. These 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.

Retaining income surtaxes could have few rates or many rates, although we 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 to avoid regressive tax rates in the short term, which takes 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 an income 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.

If the Committee rejects consumption taxes as part of tax reform, the Center offers the following recommendations:

• End the exemption for children and increase the refundable Child Tax Credit by the same amount.
• End the mortgage interest deduction and the property tax deduction for individual homes and increase the refundable Child Tax Credit by the same amount.
• End the exemption of the blind and the elderly and replace with tax credits.
• End the taxability of Social Security benefits.
• Consolidate the 10% and 15% tax rates to a single rate.
• Increase the tax rates on capital gains and dividends and lower the Corporate Income Tax rate and the 28%, 33% and 35% rates to a single rate adequate to increase revenue by $2 Trillion over 10 years.

Thank you for the opportunity to address the committee.  We are, of course, available for direct testimony or to answer questions by members and staff.

Energy Policy and Tax Reform - Infrastructure and Carbon Taxes

Comments for the Record

House Ways and Means Committee

Subcommittee on Select Revenue Measures

Subcommittee on Oversight

Joint Hearing on Energy Tax Policy and Tax Reform

Thursday, September 22, 2011, 9:30 AM

By Michael G. Bindner

Center for Fiscal Equity

Chairmen Tiberi and Boustany and Ranking Members Neal and Lewis, thank you for the opportunity to submit comments for the record on these issues.

There are three aspects to consider regarding whether energy policy should be conducted through the tax code: energy taxes as transportation user fees; energy taxes as environmental sin taxes and energy tax policies as a subsidy for business. How to design provisions for a sustainable energy policy and tax reform will be discussed for each of these areas and we will address certain oversight questions on whether current tax provisions have been implemented efficiently and effectively, although we will leave most of the latter analysis to the scheduled witnesses, as well as analysis of H.R. 1380, the NAT GAS Act.

Energy Taxes as Transportation User Fees

The most familiar energy tax is the excise tax on gasoline. It essentially functions as an automatic toll, but without the requirement for toll booths. As such, it has the advantage of charging greater tolls on less fuel efficient cars and lower tolls on more efficient cars, all without requiring purchase of a EZ Pass or counting axles.

It is a highly efficient tax in this regard, although its effectiveness is limited because it has not kept pace with inflation. This could be corrected by shifting it from a uniform excise to a uniform percentage tax – however because the price of fuel varies by location, there may be constitutional problems with doing so. The only other option to increase this tax in order to overcome the nation’s infrastructure deficit – which is appropriately funded with this tax – is to have the courage to increase it.

In this time of high unemployment, such an increase would be a balm to economic growth, as it would put people back to work. Given the competitive nature of gas prices, there is some question as to whether such an increase would produce a penny for penny increase in gasoline prices. If the tax elasticity is more inelastic than elastic, the tax will be absorbed in the purchase price and be a levy on producers. If it is more elastic, it will be a levy on users and will impact congestion (and thus decrease air pollution and overall conservation). For many citizens, either prospect is a win-win, given concerns over both climate change and energy industry profits. The only real question is one of the political courage to do what is necessary for American jobs and infrastructure –and that seems to be a very open question.

Energy taxes are currently levied through the private sector, rather than through toll booth employees, which from the taxpayer point of view is a savings as it externalizes the pension and benefit requirements associated with hiring such workers.

In the event that gasoline cars were replaced with electric cars, given either improvements in battery charging technology or in providing continuous supply through overhead wires, much in the same way that electric trains and busses receive power, any excise per kilowatt for the maintenance of roads could be collected in the same way – or the road system could be made part of a consortium with energy providers, car makers and road construction and maintenance contractors – effectively taking the government out of the loop except when eminent domain issues arise (assuming you believe such a tool should be used for private development, we at the Center believe that it should not be).

The electric option provides an alternative means to using natural gas, besides creating a gas fuelling infrastructure, with natural gas power plants providing a more efficient conduit than millions of internal combustion engines. The electric option allows for the quick implementation of more futuristic fuels, like hydrogen, wind and even Helium3 fusion. Indeed, if private road companies become dominant under such a model, a very real demand for accelerated fusion research could arise, bypassing the current dependence on governmental funding.

In the event of comprehensive tax reform, the excise for fuel would be either a component of or an addition to any broad based Value Added or VAT-like Net Business Receipts Tax. The excise should not disappear into such a general tax, as doing so would have the effect of forcing all businesses to fund transportation on an equal percentage, regardless of their use of such infrastructure. Of course, like a VAT, any gasoline excise would be accounted for using the credit receipt method, so that cascading taxes would not occur, as they do now with this excise functioning as hidden levy.

Energy Taxes as Environmental Sin Taxes

Carbon Taxes, Cap and Trade and even the Gasoline Excise are effectively taxes on pollution or perceived pollution and as such, carry the flavor of sin taxes. As such, they put the government in the position of discouraging vice while at the same time trying to benefit from it. Our comments above as to whether the tax elasticity of the gasoline excise has an impact on congestion and pollution is applicable to this issue, although tax inelasticity will mute the effect of discouraging “sinful” behavior and instead force producers to internalize what would otherwise be considered externalities – provided of course that the proceeds from these taxes are used to ameliorate problems of both pollution (chest congestion) by paying for health care and traffic congestion in building more roads and making more public transit available – while funding energy research to ease the carbon footprint of modern civilization.

Oddly enough, this approach was once considered the conservative alternative to other more intrusive measures proposed by liberals, like imposing pollution controls on cars and factories or simply closing down source polluters. When those options are taken off the table, however, or are considered impractical, then the concept of environmental sin taxes becomes liberal and no action at all becomes the conservative position.

These use of environmental sin taxes is by nature much more efficient economically than pollution controls and probably also more efficient than allowing producers and consumers to benefit from externalities like pollution, congestion and asthma. As with transportation funding, such taxes are only effective if they actually provide adequate funding for amelioration or otherwise change consumer behavior. If the politics of the day prevent taxes from actually accomplishing these objectives, then their effectiveness is diminished.

The short term political win of keeping taxes too low can only work for so long. Reality has a way of intruding, either because infrastructure crumbles, congestion becomes too high, children become ill with asthma (for full disclosure purposes, I suffered from this after moving down-wind as a child from an Ohio Edison coal plant) and sea levels rise – destroying vacation homes and the homes of those who support them – and if Edgar Cayce is to be believed – the states that are the heart of the Republican base.

The role of energy taxes as sin taxes are preserved in comprehensive tax reform only if they are preserved in addition to value added and net business receipts taxes. If there is no separate tax or higher rate for these activities, there is no sin tax effect and the “sin” is effectively forgiven with any amelioration programs funded by the whole of society rather than energy users.

Oddly enough, because the Center does not mention carbon taxes or cap and trade in our standard proposal, liberal commentators on Daily Kos criticize its lack and assume we don’t believe in them at all. This is far from the case, as our proposals say nothing about replacing such taxes with our proposed VAT and NBRT. Our proposal is to replace low and mid rate income taxes, corporate income taxes and non-OASI payroll taxes with these revenues. We simply don’t touch the question of any other excise. This shows how much the fortunes of energy taxes have changed since Vice President Gore suggested their inclusion in President Clinton’s tax proposals.

Energy Tax Policies as a Subsidy for Business

There are quite a few ways in which energy tax policy subsidizes business. The most basic way is the assessment of adequate energy taxes, or taxes generally, to pay for government procurement of infrastructure and research. If tax reform does not include adequate revenue, the businesses which fulfill these contracts will be forced to either reduce staff or go out of business. Government spending stimulates the economy when more money is spent because taxes are raised and dedicated (or even earmarked) for these uses. Eliminating specific energy taxes in tax reform forces this work into competition with other government needs.

Let me be clear that the Center does not propose such a move. Our approach actually favors more, not less, identification of revenues with expenditures, reducing their fungibility, with the expectation that taxes increase when needs are greater and decrease when they are met, either through building in advance of need or finding an alternative private means of providing government services.

The more relevant case to Committee’s question is the existence of research and exploration subsidies as they exist inside of more general levies, such as the Corporate Income Tax. To the extent to which tax reform eliminates this tax and replaces it with reforms such as the Net Business Receipts Tax (which taxes both labor and profit), such subsidies are problematic, but not impossible to preserve.

This is one of the virtues of a separate Net Business Receipts Tax, rather than replacing the Corporate Income Tax with a VAT or a Fair Tax – which by their nature have no offsetting tax expenditures. The challenge arises, however, when the existence of such subsidies carry with them the very justified impression that less well connected industries must pay higher taxes in order to preserve these tax subsidies. Worse is the perception, which would arise with their use in a business receipts tax, that such subsidies effectively result in lower wages across the economy. Such a perception, which has some basis in reality, would be certain death for any subsidy.

One must look deeper into the nature of these activities to determine whether a subsidy is justified, or even possible. If subsidized activities are purchased from another firm, the nature of both a VAT and an NBRT alleviate the need for any subsidy at all, because the VAT paid implicit in the fees for research and exploration would simply be passed through to the next level on the supply chain and would be considered outside expenditures for NBRT calculation and therefore not taxable. If research and exploration is conducted in house, then the labor component of these activities would be taxed under both the VAT and the NBRT, as they are currently taxed under personal income and payroll taxes now.

The only real issue is whether the profits or losses from these activities receive special tax treatment. Because profit and loss are not separately calculated under such taxes, which are essentially consumption taxes, the answer must be no. The ability to socialize losses and privatize profits through the NBRT would cease to exist with the tax it is replacing.

If society continues to value such subsidies, they would have to come as an offset to a carbon tax or cap and trade regime, if at all, as the excise tax for energy is essentially a retail sales tax and the industrial model under which the energy industry operates insulates the gasoline excise from the application of any research and exploration credits. If the energy companies were to change their model to end independent sales and distribution networks and treat all such franchisees as employees (with the attendant risk of unionization), then the subject subsidies could be preserved – provided that the related energy tax is increased so that the subsidy could actually operate – favoring those who participate in research and development and penalizing those who do not.

In other words, if big oil wants to keep this subsidy when there are no corporate income tax, it must buy up all its franchisees and allow the government to double the gasoline tax with a deduction at payment for research and exploration.

Without taxes, there can be no subsidy.

The last subsidy issue involves the use of a Value Added Tax as an oil import fee. If the VAT replaces some percentage of current employee and investor income taxes, domestically produced energy products become more competitive on the world market, provided that the VAT is border adjustable, which it would be. For example, if Alaska crude is shipped to Japan for refining and use or western low-sulfur coal is shipped to China, it would be cheaper than the same product shipped under today’s tax system.

The NBRT would not be border adjustable because it is designed to pay for entitlement costs which benefit employees and their families directly, so that it is appropriate for the foreign beneficiaries of their labor to fund these costs. Additionally, the ultimate goal of enacting the NBRT is to include tax expenditures to encourage employers to fund activities now provided by the government – from subsidies for children to retiree health care to education to support for adult literacy. Allowing this tax to be zero-rated at the border removes the incentive to use these subsidies, keeping government services in business and requiring higher taxation to support the governmental infrastructure to arrange these services – like the Committee on Ways and Means.

Thank you again for the opportunity to present our comments. We are always available to discuss them further with members, staff and the general public.

Hearing: Expiring Medicare Provider Payment Policies

Comments for the Record

House Committee on Ways and Means

Subcommittee on Health

Hearing: Expiring Medicare Provider Payment Policies

September 21, 2011, 2:00 PM

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.  This topic is key to the question of the affordability of health care entitlements.  It is useful to compare the impact of how provider limits have been dealt with between the Medicare and Medicaid programs.

Medicare provider cuts under current law have been suspended for over a decade, the consequence of which is adequate care.  By way of comparison, Medicaid provider cuts have been strictly enforced, which has caused most providers to no longer see Medicaid patients, driving them to hospital emergency rooms and free clinics with long waiting periods to get care.

The Affordable Care Act works toward increasing funds for Medicaid providers, which is necessary to get people out of emergency rooms.  The same act, however, counted on assuming that Medicare provider cuts would be implemented – a heroic assumption – in order to pass according to budget rules.  Now that the Act is passed, however, the fiction that current law will be maintained can be dispensed with.

Parity between Medicare and Medicaid is desirable, although without mandatory sick leave, it will not keep poor people from having to use emergency room care, although it will benefit nursing home patients who will be able to see a doctor without hospitalization.

Separating Medicaid into a program for retirees and a program for the non-retired working and non-working poor will allow the retiree program to be fully federalized and managed with Medicare, rather than the separate management that occurs now under CMMS, which is part of the problem.  That simple step will add clarity to this issue.

There are many ways of achieving parity, however great care must be used so that these don’t constitute a race to the bottom.  Cost shifting should not be used as a substitute for cost saving, especially if such shifting violates the tenants of social insurance.

The whole purpose of social insurance is to prevent the imposition of unearned costs and payment of unearned benefits by not only the beneficiaries, but also their families.  Cuts which cause patients to pick up the slack favor richer patients, richer children and grand children, patients with larger families and families whose parents and grandparents are already deceased, given that the alternative is higher taxes on each working member.  Such cuts would be an undue burden on poorer retirees without savings, poor families, small families with fewer children or with surviving parents, grandparents and (to add insult to injury) in-laws.

Recent history shows what happens when benefit levels are cut too drastically.  Prior to the passage of Medicare Part D, provider cuts did take place in Medicare Advantage (as they have recently).  Utilization went down until the act made providers whole and went a bit too far the other way by adding bonuses (which were reversed in the Affordable Care Act).  There is a middle ground and the Subcommittee’s job is to find it.

Resorting to premium support, along with the repeal of the ACA, have been suggested to save costs.  Without the ACA pre-existing condition reforms, mandates and insurance exchanges, however, premium support will not work because people will have no assurance of affordable coverage.  This, of course, assumes that private insurance survives the imposition of pre-existing condition reforms.  If it does not, the question of both premium support and the adequacy of provider payments is moot, since if private insurance fails the only alternatives are single-payer insurance and a pre-emptive repeal of mandates and protections in favor of a subsidized public option.  The funding of either single-payer or a public option subsidy will dwarf the requirement to fund adequate provider payments in Medicare and Medicaid.

Resorting to single-payer catastrophic insurance with health savings accounts would not work as advertised, as health care is not a normal good.  People will obtain health care upon doctor recommendations, regardless of their ability to pay.  Providers will then shoulder the burden of waiting for health savings account balances to accumulate – further encouraging provider consolidation.  Existing trends toward provider consolidation will exacerbate these problems, because patients will lack options once they are in a network, giving funders little option other than paying up as demanded.

Shifting to more public funding of health care in response to future events is neither good nor bad.  Rather, the success of such funding depends upon its adequacy and its impact on the quality of care – with inadequate funding and quality being related.

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).  

We will now move to an analysis of funding options and their impact on patient care and cost control.

The committee well understands the ins and outs of increasing the payroll tax, so we will confine our 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, an 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 NBRT can provide an incentive for cost savings if we allow employers to offer services privately to both employees and retirees in exchange for a substantial tax benefit, either by providing insurance or hiring health care workers directly and building their own facilities. Employers who fund catastrophic care or operate nursing care facilities 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 arrest 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.

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.

Thank you for the opportunity to address the committee.  We are, of course, available for direct testimony or to answer questions by members and staff.

Economic Models Available to the Joint Committee on Taxation for Analyzing Tax Reform Proposals

Comments for the Record

House Ways and Means Committee

Hearing on Economic Models Available to the Joint Committee on Taxation for Analyzing Tax Reform Proposals

Wednesday, September 21, 2011, 10:00 AM

1100 Longworth House Office Building

By Michael G. Bindner

Center for Fiscal Equity

Chairman Camp and Ranking Member Levin, thank you for the opportunity to submit comments on these issues. The Center for Fiscal Equity feels three types of models merit attention.

The first type of model needed is a robust model for the estimation of both revenue and the impact on the economy of consumption taxes, which include the FairTax, Value Added Taxes and a VAT-like Net Business Receipts Tax. The Center for Fiscal Equity bases its estimates for VAT and NBRT revenues on estimates developed by the Brooking-Urban Tax Policy Center, which estimate that a 5% broad based VAT would raise $259 Billion after reductions in other types of revenue are factored in.

We suggest that the JCT validate this model and its sensitivity range. For example, do these estimates imply that a 10% VAT would yield $518 Billion in net revenue? Would a 25% broad based NBRT yield $1.285 Trillion? A robust set of estimates by the JTC would keep everyone on the same page in proposing various revenue options.

The second type of model needed for tax reform and deficit reduction is an estimate of the economic effects of various spending and tax benefit programs. The following questions come to mind:

• What is the impact of defense contracting versus Medicare provider payments versus the Child Tax Credit versus lower dividend tax rates?
• Do lower tax rates on the wealthy cause growth or do they provide an incentive to firms to pursue productivity gains, including off-shoring jobs, union busting and holding wages in line?
• What is the impact of these policies on the middle class?
• What is the impact of these policies on inflation?
• How do tax policies relate to the creation of asset bubbles, especially when capital gains taxes are cut, as they were in 1997, when the Technology Boom was fueled, only to be followed by the Tech Bubble popping and the 2001 recession?
• On all of these models, is there a lag effect between outlays of various types and their full impact on the economy?
• How does each type of spending effect consumption, savings and investment?
• What are the secondary effects as households and firms then spend the money they receive, including the effect on federal and state revenues?
• Is aerospace procurement more likely to stimulate spending the, for example, a tax cut to aerospace executives?
• How does each affect investment in both plant and equipment and in the secondary markets?

The third type of model relates to how deficit financing effects economic growth rates in the aggregate. With a large debt, are deficits partly offset by outlays for net interest, with the size of the deficit being offset by such outlays when they are approximately equal? How do these effects relate to tax policy? When tax policy is more progressive, yielding more revenue from wealthier taxpayers, is budget balancing stimulative? When tax rates are cut and revenue falls, are deficits required to keep money in circulation?

The Center for Fiscal Equity has developed figures relating to the third model, which we call the financial margin, where the financial margin is the deficit/surplus added to outlays for net interest, all expressed as a percentage of Gross Domestic Product (GDP) and regressed onto growth in real GDP in the next year, removing inflation from the analysis. See the following table for the data set used in these analyses.  (Click on image to see larger text).

This repeats a study we performed but did not publish in 1987, which showed that Republican administrations generally must run bigger deficits to yield economic growth, but Democratic administrations generally did not. Indeed, these administrations had better economic performance by raising marginal tax rates on wealthier households.

For the Eisenhower years, roughly fiscal year 1954 – 1960, budget results predict growth in 1955-1961.The model explains 47% of the variation of the data and predicts a base growth rate of 4.1% with a 1.38% less growth for every 1% of GDP decrease in the financial margin – meaning that deficits were necessary to keep growing the economy. While tax rates were high, these rates were not designed to raise revenue, but to assure that middle class jobs were preserved.

The Kennedy and pre-war Johnson years show a much different picture. In a model which explains 98% of the variation, 3.13% of growth results from every 1% increase in the financial margin, with a base growth rate of 4.2%. In other words, paying back debt led to more growth.

The Viet Nam era results explain 53% of the variation, with a base growth rate of 3.6% and 1.16% of additional growth for every 1% of GDP reduction in the financial margin. Deficit spending is again required for increased growth.

The postwar model explains 66% of the variation, with a base growth rate of 0.2% and 2.3% of growth resulting from every 1% decrease in the financial margin, showing deficit spending was necessary to yield growth in the economy.

For the Reagan-Bush years as a whole, the model explains 37% of variation for the period 1981-1992, with a base growth rate of 1.4% and 1.3% of additional growth resulting from every percent GDP of deficit spending net of net interest. Isolating 1981-1986 yields a model which explains 96% of the variation. With a base growth rate of -2.0 %, 2.9% of growth is produced for every one percent of GDP decline in the financial margin – meaning budget balancing hurt the economy and deficits were necessary to grow it.

 

When George H.W. Bush and Bill Clinton raised taxes and controlled spending, more growth resulted, with 0.33% of growth resulting from each additional percentage of debt reduction, in a model that explains 72 percent of the variation, with a base growth rate of 3.4%.

The curve changes to negative once fiscal policy changed direction. In a model that explains 57% of the variation and a base growth rate of 2.4%, achieving a 1% growth rate requires an additional 0.27 percent of GDP loss in the financial margin – meaning the anemic growth of the last decade was fueled by deficits.

We believe that a Keynesian relationship explains these findings. When fiscal policy in the aggregate takes more money out of the bond markets after taxes have been cut, the running of deficits (net of interest payments) reduces savings and increases consumption by both the government and households.

When budget balancing using tax increases aimed at lower wage workers occurs, such as an increase in the payroll tax or “sin taxes” or through cuts to spending, such as Gramm-Rudman-Hollings, and deficits are smaller compared to net interest, the economy contracts as the savings sector on average increases at the expense of both government and household spending.

When budget balancing occurs because of higher marginal tax rates, however, money is removed from the savings sector in comparison to the consumption sector, making more credit available as well as higher government and household consumption.

This is essentially what happened when Presidents Bush and Clinton raised taxes in the 90s. Even though the budget neared and achieved balance, consumption continued in both the government and household sectors, although there were cuts, both absolute and programmatic, in the defense sector, while credit was widely available. When capital gains tax rates were cut in 1997, however, the savings sector received a greater share of output, resulting in an investment boom which we now know exceeded the availability of high value investment opportunities, driving up both asset prices and allowing junk investments to enter the market, which could not provide adequate returns in most cases, causing the 2001 recession.

The tax cuts of 2001 and 2003 reduced revenue and increased deficits to record levels in the post-war era, with further asset inflation leading to the current economic depression, especially in the housing market.

This brings us to the current economic situation. The Great Recession as obviously shifted the Financial Margin curve. While the current curve has few data points, these observations are consistent with both theory and economic data in the post-war era.

Assuming that projections in the President’s budget are accurate for 2011, it is possible to compute an estimate for FY2012 growth using FY2011 data and the current model. If the 2011 growth is estimated using the model rather than Administration projections, growth will be lower by half a percentage point. Using the model, 2012 growth based on current fiscal year spending is projected at 3.5%, provided that spending is not cut too much. In this model, lower spending results in a more anemic recover.

The Joint Committee on Taxation is urged to examine this model, as it has major implications for the road forward. Cutting the budget too aggressively could result in disaster, however allowing the Clinton tax rates to expire may allow the economy to return to the curves experienced in the early 1960s or the 1990s.

Our comments raise serious issues that must be dealt with in determining fiscal policy in the near term. Further adherence to current tax policy may lock us into a model where unsustainable debt is necessary to sustain the economy. Finding a way out of this debt by reverting to a more rational tax policy, based on these data, is essential.

Thank you again for the opportunity to present our comments. We are always available to members, staff and the general public to discuss these issues.

The Broken Budget Process

Comments for the Record

U.S. House of Representatives

Committee on the Budget

The Broken Budget Process: Perspectives from Former CBO Directors

210 Cannon House Office Building

September 21, 2011, 10:00 AM

By Michael G. Bindner

Center for Fiscal Equity

Chairman Ryan and Ranking Member Van Hollen, thank you for the opportunity to submit comments for the record on this issue. These comments were first published on our web page in 2003 and are as equally valid now as they were then.

For most of recent memory, especially in years where large deficits loom, the Congress and the President have been unable to reach consensus on a budget in time for the start of the fiscal year on October first. This is almost scandalous, given the impact of the federal government on the economy. The lives of millions of hardworking public servants and contractors hang in the balance while Congress debates, or more likely stalemates. While it is healthy to debate the nature of government from time to time, holding the nation hostage to stage it is not.

When the government is divided between the parties, budgets are submitted "dead on arrival.” This leads to a series of missed deadlines and a likely impasse that threatens to shut the government down at the beginning of the fiscal year. Often, the impasse leads to the need for an Omnibus Appropriation Act, with its attendant pork barrel spending to assure passage (a practice which further undermines citizen confidence in the Federal Government). The same wasteful programs and tax benefits get funded and the budget crisis goes on. This goes on because each side gains political points for blaming the other, while no one has any stake in lessening their own role.

The federal budget process is broken. It must be replaced with a new budget process that allows for agreement on broad issues and a continuation of government while the details and controversies at the programmatic level are worked out. The solution must include incentives to keep the process moving. To force congressional movement on overall priorities, the administration withholds detailed appropriations proposals until a general solution is passed in both houses of Congress and signed by the President (a Joint Budget Resolution). After this is passed, detailed proposals are submitted and acted upon by the authorization and appropriations committees. A two-year budget process is suggested to assure the process is completed on time.

Phase One: The Joint Budget Resolution
The first phase of the budgetary process is high-level budget enactment. The budget message, revenue estimates and increases, departmental, independent agency and functional spending totals, and deficit projections are included in the Joint Budget Resolution proposal. Until the resolution is enacted the Executive withholds detailed spending estimate or authorizing language. The proposal is submitted to Congress during mid-January, with passage of the Joint Budget Resolution by the July 4th recess.

A Joint Committee on the Budget considers the resolution. The Committee consists of members of the leadership of both houses, various committee chairs and members, and members not assigned to any major authorizing or appropriations committee (who shall be a majority). The Chair alternates between chambers. Such a committee is necessary to expedite action.

After the Committee reports the resolution it is considered in an expedited fashion. If there are differences between the amended versions of the resolution it goes back to the Committee one final time, and acts as a conference committee in this case.

The Executive Branch uses the totals enacted in the Joint Budget Resolution as the totals in its detailed authorizations and appropriations submissions.

Phase Two: Authorization
The second phase of the budgetary process is authorization, which begins after the Joint Budget Resolution is signed, in July of the first session. Most of the authorization process is accomplished before the appropriations process begins. To guarantee this, no appropriations bill is marked up in committee in either house until the authorization bill has secured floor passage in that house, including tax and entitlement adjustments. This occurs by February of the second session. At the start of a new President's term honeymoon authorizations changes are submitted by February, with enactment by September so that they take effect October first.

Authorization legislation addresses changes to current law, revised spending ceilings and floors (which the marked up appropriations bills does not exceed or fall short of subject to a point of order), any new programs or program elimination (the only time these occur), changes to agency regulations, adjustments to any entitlement, and estimates of their effect on the next fiscal period.

The revenue committees examine the progressivity of both taxation and spending to assure that the middle class pays for itself and the upper 20% pay for the benefits they receive plus a lions share of the benefits for the bottom 20% of income earners. Corrections in the tax code are enacted as a result of this review. The revenue committees also examine the level for cost of living adjustments (COLAs) and indexing. COLAs and indexing are adjusted so the public sector neither looses or gains as the result of inflation.

As part of this process, authorizing committees consider major regulations enacted since the last authorization. Doing so avoids the practice of appropriators playing games with the funding of regulatory agencies, since Congress has the opportunity to work its will during the authorization process. Before continuing on to the appropriations phase, I briefly discuss ways in which regulatory power is exercised in such a way as to not appear illegitimate by the vast majority of the public.

Increasing Congressional Review of Regulation
A major theme in modern political life is the popular protest against regulations enacted by unelected bureaucrats. This anti-Washington theme aided the campaigns of many recent administrations, including the current one. Other reforms in the regulatory review process increased regulatory accountability to the President. However, these did little to improve the position of Congress.

On June 30, 1983, the Supreme Court ruled the legislative veto unconstitutional in an immigration case, In re Chada. Since that time a Joint Resolution of Disapproval legislative veto has been enacted as a general case. Several other legislative vetoes have also been acted into law. However, many of these cannot survive the standards imposed by the Chada decision. Therefore, Congressional control of agency regulation remains an open question.

To regain control of regulations, authorization committees review the body of regulations under their purview during consideration of the President’s budget. The President or Independent Agencies submit any changes to their major regulations (enacted since their last authorization) as an appendix to their authorization proposals. If the authorizing committees approve of the changes they do nothing. However, if they are unsatisfied with the changes, or wish to make changes of their own they can at this juncture. These changes are made one of two ways. The first way is to write the change into law, which restricts subsequent action. If circumstances change the agency then seeks legislative relief or waits until the next authorization cycle. This option limits the ability of agencies to deal with emergencies, making it undesirable. The second way is to change agency regulation by law, allowing for further change as circumstance changes. This almost superficial difference preserves flexibility in the regulatory process, making it desirable.

Enactment of this proposal firmly places regulatory initiative with the Congress. This approach gives the people say in the regulatory process through Congress, strengthening representative government. In doing so it helps the less well organized (who know how to reach their Congressman, but not the administrative agency). The regulatory review provisions have two more advantages over the status quo. First, they bring the regulatory review process into sharper view, allowing for more involved citizen input. Second, they avoid the constitutional pitfalls of the legislative veto.

Phase Three: Appropriations
The third phase of the budgetary process is appropriations. The Executive Branch begins preparing its detailed appropriation submissions after passage of the Joint Budget Resolution in July of the previous year. It modifies its targets when Authorization legislation is marked up. The Appropriations submissions clear OMB and go to the Hill by March 15th of the second session. The submissions for each program are between the ceiling and floor listed in the authorization legislation. The total for the agency or department matches the total found in the Joint Budget Resolution. Agency submissions reflect program financial performance. Agency personnel defend the submission.

Appropriations sub-committees do not mark up legislation until after the authorization has cleared the full chamber. The full Appropriations Committees reports by June 15. If the total for an appropriations bill exceeds the total specified in the Joint Resolution the bill must clear the Joint Budget Committee before going to the floor. Legislation gets to the President's desk by Labor Day.

If an appropriations bill is not enacted prior to the start of the fiscal period (October 1) the current distribution of spending within current law is maintained, minus programs cancelled in the authorization phase, at the total set in the Joint Budget Resolution. This prevents the government from stopping at the end of the fiscal year.

Enactment of this proposal restores discipline to the budget process. Every actor in the process has specific responsibilities and incentives to meet them. Each actor maintains his share in the process, but not more than his share. The Executive Branch is forced to offer realistic proposals. The Legislative Branch meets its deadlines. The Federal Government then stops arguing about the budget and gets on with the business of governing.

There is support for these propositions in the academic and professional literature. Thomas Lynch of Florida Atlantic University also advocates a two-step budget process in "Federal Budget Reform," beginning with passage of a Joint Budget Resolution, which sets overall spending priorities. After this resolution passes agencies submit their requests, which are considered in detailed budget and bills. The strength of this approach is that it forces Congress to decide on overall priorities before they can begin to consider their local interests. Rudolph Penner and Alan Abramson, in their landmark book Broken Purse Strings, support the establishment of a Joint Budget Committee (echoing Senator Pete Domenici), a Joint Budget Resolution and multi-year budgeting.

Thank you for the opportunity to address the committee. We are, of course, available for direct testimony or to answer questions by members and staff.

Hearing: Dually-Eligible Beneficiaries: Improving Care While Lowering Costs

Comments for the Record

United States Senate Committee on Finance

Hearing: Dually-Eligible Beneficiaries: Improving Care While Lowering Costs

September 21, 2011, 10:00 AM

215 Dirksen Senate Office Building

by Michael G. Bindner

The Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for the opportunity to address this topic. We offer our comments on three areas of this topic, program organization, program parity and program funding.

Separating Medicaid into a program for retirees and the disabled and a program for the non-retired working and non-working poor will allow the retiree program to be fully federalized and managed with Medicare, rather than the separate management that occurs now under CMMS, which is part of the problem. That simple step will add clarity to this issue as the senior and disabled Medicare and Medicaid populations can be managed by the same offices, rather than separately. The question then shifts from parity to effective consolidation – at least on the Medicare side. All retirees and the disabled would be treated under parts A, B and D all the time, including while in nursing home care (part E). Rates would require parity in all settings, however.

The issue of parity is especially important in the area of provider limits. It is useful to compare the impact of how provider limits have been dealt with between the Medicare and Medicaid programs.

Medicare provider cuts under current law have been suspended for over a decade, the consequence of which is adequate care. By way of comparison, Medicaid provider cuts have been strictly enforced, which has caused most providers to no longer see Medicaid patients, driving them to hospital emergency rooms and free clinics with long waiting periods to get care.

The Affordable Care Act works toward increasing funds for Medicaid providers, which is necessary to get people out of emergency rooms. The same act, however, counted on assuming that Medicare provider cuts would be implemented – a heroic assumption – in order to pass according to budget rules. Now that the Act is passed, however, the fiction that current law will be maintained can be dispensed with.

Parity between Medicare and Medicaid is desirable, although without mandatory sick leave, it will not keep poor people from having to use emergency room care, although it will benefit nursing home patients who will be able to see a doctor without hospitalization.

There are many ways of achieving parity, however great care must be used so that these don’t constitute a race to the bottom. Cost shifting should not be used as a substitute for cost saving, especially if such shifting violates the tenants of social insurance.

The whole purpose of social insurance is to prevent the imposition of unearned costs and payment of unearned benefits by not only the beneficiaries, but also their families. Cuts which cause patients to pick up the slack favor richer patients, richer children and grand children, patients with larger families and families whose parents and grandparents are already deceased, given that the alternative is higher taxes on each working member. Such cuts would be an undue burden on poorer retirees without savings, poor families, small families with fewer children or with surviving parents, grandparents and (to add insult to injury) in-laws.

Recent history shows what happens when benefit levels are cut too drastically. Prior to the passage of Medicare Part D, provider cuts did take place in Medicare Advantage (as they have recently). Utilization went down until the act made providers whole and went a bit too far the other way by adding bonuses (which were reversed in the Affordable Care Act). There is a middle ground and the Subcommittee’s job is to find it.

Resorting to premium support, along with the repeal of the ACA, have been suggested to save costs. Without the ACA pre-existing condition reforms, mandates and insurance exchanges, however, premium support will not work because people will have no assurance of affordable coverage. This, of course, assumes that private insurance survives the imposition of pre-existing condition reforms. If it does not, the question of both premium support and the adequacy of provider payments is moot, since if private insurance fails the only alternatives are single-payer insurance and a pre-emptive repeal of mandates and protections in favor of a subsidized public option. The funding of either single-payer or a public option subsidy will dwarf the requirement to fund adequate provider payments in Medicare and Medicaid.

Resorting to single-payer catastrophic insurance with health savings accounts would not work as advertised, as health care is not a normal good. People will obtain health care upon doctor recommendations, regardless of their ability to pay. Providers will then shoulder the burden of waiting for health savings account balances to accumulate – further encouraging provider consolidation. Existing trends toward provider consolidation will exacerbate these problems, because patients will lack options once they are in a network, giving funders little option other than paying up as demanded.

Shifting to more public funding of health care in response to future events is neither good nor bad. Rather, the success of such funding depends upon its adequacy and its impact on the quality of care – with inadequate funding and quality being related.

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).

We will now move to an analysis of funding options and their impact on patient care and cost control.

The committee well understands the ins and outs of increasing the payroll tax, so we will confine our 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, an 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 NBRT can provide an incentive for cost savings if we allow employers to offer services privately to both employees and retirees in exchange for a substantial tax benefit, either by providing insurance or hiring health care workers directly and building their own facilities. Employers who fund catastrophic care or operate nursing care facilities 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 arrest 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.

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.

Thank you for the opportunity to address the committee. We are, of course, available for direct testimony or to answer questions by members and staff.

Tax Reform Options: Incentives for Innovation

Comments for the Record

United States Senate Committee on Finance

Tax Reform Options: Incentives for Innovation

Tuesday, September 20, 2011, 10:00 AM

215 Dirksen Senate Office Building

By Michael Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for the opportunity to address this topic. As you know, the Center for Fiscal Equity suggests a four part tax reform, which form the basis of our analysis. The key elements are:

• a Value Added Tax (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 incentives to innovation in the current tax code are only relevant to the extent that wages and profit are taxed separately through income and payroll taxes. Such incentives are difficult, though not impossible to preserve in tax reform to the extent that tax reform eliminates the Corporate Income Tax on profit and replaces it with reforms such as a Value Added Tax and a VAT-like Net Business Receipts Tax (which tax both labor and profit). As Value Added Taxes never contain offsetting tax benefits, we will confine our remarks to offsets to Net Business Receipts Taxes.

One of the virtues of an NBRT is that offsets are possible, which is not the case with a VAT or the FairTax. The challenge arises, however, when the existence of such subsidies carry with them the very justified impression that less well connected industries must pay higher taxes in order to preserve these tax subsidies. Worse is the perception, which would arise with their use in a business receipts tax, that such subsidies effectively result in lower wages across the economy. Such a perception, which has some basis in reality, would be certain death for any subsidy.

One must look deeper into the nature of these activities to determine whether a subsidy is justified, or even possible. If subsidized activities are purchased from another firm, the nature of both a VAT and an NBRT alleviate the need for any subsidy at all, because the VAT paid implicit in the fees for research and exploration would simply be passed through to the next level on the supply chain and would be considered outside expenditures for NBRT calculation and therefore not taxable. If research and exploration is conducted in house, then the labor component of these activities would be taxed under both the VAT and the NBRT, as they are currently taxed under personal income and payroll taxes now.

The only real issue is whether the profits or losses from these activities receive special tax treatment. Because profit and loss are not separately calculated under such taxes, which are essentially consumption taxes, the answer must be no. The ability to socialize losses and privatize profits through the NBRT would cease to exist with the tax it is replacing.

The last question concerns repatriation of overseas profits now taxable under the corporate income tax. The answer to this question depends on the tax impacted. Clearly such repatriations would have not impact on VAT collection, as VAT would have been collected where the item is sold. If the item were made in the USA and exported, the returning funds would be tax free. Indeed, collecting such funds would be tantamount to a constitutionally prohibited export tax.

The NBRT would not be border adjustable because it is designed to pay for entitlement costs which benefit employees and their families directly, so that it is appropriate for the foreign beneficiaries of their labor to fund these costs. Additionally, the ultimate goal of enacting the NBRT is to include tax expenditures to encourage employers to fund activities now provided by the government – from subsidies for children to retiree health care to education to support for adult literacy. Allowing this tax to be zero-rated at the border removes the incentive to use these subsidies, keeping government services in business and requiring higher taxation to support the governmental infrastructure to arrange these services – like the Committee on Finance.

The NBRT is collected based on where costs are incurred and dividends paid. Therefore, if foreign profits are repatriated and used to finance American research and development activities and distribution of dividends to American shareholders (or foreign shareholders based in the United States), NBRT would be due on researcher salaries and dividends paid out. Finally, dividends paid out to individuals responsible for paying the income and inheritance surtax would be fully taxable under that levy as if they were paid out from American operations.

Thank you again for the opportunity to present our comments. We are always available to discuss them further with members, staff and the general public.