Hearings to Examine the History and Drivers of our Nation's Debt and its Threat

Comments for the Record

United States Joint Select Committee on Deficit Reduction

Hearings to Examine the History and Drivers of our Nation's Debt and its Threat

Tuesday, September 13, 2011, 10:30 AM

216 Hart Senate Office Building

By Michael Bindner

Center for Fiscal Equity

Chairwoman Murray and Vice Chairman Hensarling, thank you for the opportunity to address this topic. We will leave it to the scheduled witnesses to report the data on how we got to the current debt levels and the gloom and doom scenarios inherent in not fixing the debt problem inherent in not making cuts while extending current tax policy. Rather, we will draw the obvious conclusions based on these data and point out what must be done next.

The facts speak for themselves. Both spending and tax policy brought us to this point, with defense buildups in the 1980s and 2000s under President’s Reagan and Bush 43 coupled with tax cuts in 1981, 2001 and 2003, the Clinton era capital gains cut and the tax reform of 1986 all contributing to the current crisis. Not only have these policies driven the budget out of relative balance, but have, on the margins, given management and ownership of American companies a direct personal incentive to extract productivity gains from American workers, including automation, wages restricted to the level of inflation, declining benefits and job losses to overseas production facilities. This has left the middle class no choice but to rely on debt to maintain and improve their standard of living – leading us to the current household debt crisis.

I say this not to alienate half of the committee, but to indicate the obvious way forward.

The main impetus for this committee is the expiration of the 2001, 2003 and 2010 tax cuts on December 31, 2012. If bondholders were not worried that extending these cuts would not be paid for, there would be no need for the Joint Select Committee to exist. Indeed, if the economy were stronger, the President could promise to veto any extension of these cuts and the long term economic picture would be fine, as the permanent tax structures are adequate to capture the income to doctors, hospitals, and suppliers from any additional health care cost growth due to the retirement of the baby boom generation, where current tax policy does not. Simply abandoning current policy for permanent law fixes the long term picture with no further reform.

Given my analysis of the effect of lower taxes on incentives to extract productivity gains, it may even be that higher taxes are essential to further economic recovery, as the incentive to continue to make productivity gains is alive and well in the private sector. Simply reversing these incentives would likely improve the performance of the economy, as workers would have more money and begin to spend again. $20 a week is no major disincentive to spend more – while job insecurity because management wants a bonus is.

I do not expect the Republicans on this committee to suddenly accept Keynes. Indeed, it is impossible to go back in time and reverse the tax policies of the 1980s and 2000s and see what would happen without them. Indeed, an argument can be made that without giving management and ownership an incentive to extract productivity gains, the inflation of the 1970s may still be with us. Rather, the purpose of this analysis is to indicate a way forward.

For this committee to be ultimately successful, it must expressly offset any spending cuts with changes in tax policy –from the preservation of such items as the 10% tax rate and the $1000 child tax credit to comprehensive tax reform. Indeed, seeking only $1.5 trillion in offsets is not achievable at all – not because the cuts cannot be made but because the tax policy offsets could never be agreed to. Confining the permanent cuts to the lower end would allow the President to veto any extension of the tax cuts at the upper end – and there is no possibility that the Republican caucus would allow that. This committee must make a $4 trillion deal at the very least and this deal must make the question of extending the expiring tax cuts moot.

The Center for Fiscal Equity has a four part proposal for long term tax and health care 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.

The VAT would fund domestic military and civil discretionary spending, but not overseas deployments or strategic nuclear forces. Ideally, this spending would be considered regionally, with regionally specific VAT rates (which would require a constitutional amendment to enact) along with a balance requirement with automatic rate increases and sequestration should balance not be met (also requiring an amendment). Until regional excises are permitted, we estimate a national balanced budget VAT of 13%.

Before moving on, there are other objections to VAT that must be addressed. It is likely that for many, this unavoidability of payment is one of the reasons such taxes are opposed. This features is likely one of the main reasons that VAT is superior to the 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.

The NBRT 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 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 $520 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 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.

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.

Retaining income surtaxes 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 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.

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.