Tax Reform in an Era of Hyper-Deficits

by Jon FormanProfessor in Residence

IRS Office of Chief Counsel(Room 3501; 622-7639)

&Alfred P. Murrah Professor of Law

University of OklahomaNorman, Oklahoma

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Overview• The Budget Outlook

– Short-term• 2010 Federal Budget

– Long-term• Congressional Budget Office• Government Accountability Office

• Fiscal Gap

• Taxes,Tax Expenditures, and Tax Reform

Projected Budget Totals

Budget Totals, $billions 2010 2010-2019

Receipts $2,381 $35,250

Outlays $3,552 $42,219

Deficit $1,171 $ 6,969

Budget Totals, % GDP

Receipts 16.2% 18.7%

Outlays 24.1% 22.6%

Deficit 8.0% 3.9%

3Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009), at 114 (table S-1).

4U.S. Department of the Treasury, Financial Management Service, A Citizen’s Guide to the Financial Report of the United States Government (2008), at 4.

Where Does the Money Go?

5U.S. Department of the Treasury, Financial Management Service, A Citizen’s Guide to the Financial Report of the United States Government (2008), at 3.

Proposed Budget Receipts

Receipts, $billions 2010 2011

Individual income taxes 1,061 1,243

Corporation income taxes 222 302

Payroll taxes 940 995

Excise taxes 77 75

Estate and gift taxes 20 23

Custom duties and other receipts 58 67

Total receipts 2,381 2,713

Total outlays 3,552 3,623

Deficit, $billions 1,171 912

Deficit, % GDP 8.0% 5.9%

6Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009), at 119 (table S-4).

Deficits and Public Debt

7Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009), at 114 (table S-1).

Deficit 2008 2009 2010 2011 2012 2019

$billions 459 1,752 1,171 912 581 712

% GDP 3.2% 12.3% 8.0% 5.9% 3.5% 3.1%

Public Debt

$billions 5,803 8,364 9,509 10,436 10,985 15,370

% GDP 40.8% 58.7% 64.6% 67.3% 66.7% 67.2%

Congressional Budget Office, The Economic and Budget Outlook (November 24 2009), at 7.

Congressional Budget Office, Presentation to The Group of Thirty “Exit Strategy” for Fiscal Policy (December 4, 2009), at 9.

10Majority Staff, Senate Budget Committee, Brief Analysis, President Obama’s FY 2010 Budget (February 27, 2009), http://budget.senate.gov/democratic/index.html.

Growth of Real GDP

3.8

1.3

4.8

2.7

0.81.5

4.8

-0.2

0.9

-5.4-6.4

3.5

-0.7-0.5

4.8

3.0 2.8

0.1

2.6

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2005 2006 2007 2008 2009

(Quarterly percent change at annual rate)

Department of the Treasury, Treasury Bulletin 3 (December 2009) http://fms.treas.gov/bulletin/b2009_4poe.doc.

Department of the Treasury, Treasury Bulletin 4 (December 2009) http://fms.treas.gov/bulletin/b2009_4poe.doc.

Payroll Employment

-208 -226

-553

-691

-428

-153-113

8071105109151

255

88

206

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

300

400

I II III IV I II III IV I II III IV I II III

(Average monthly change in thousandsfrom end of quarter to end of quarter)

2007 20082006 2009

Unemployment Rate

3.54.04.55.05.56.06.57.07.58.08.59.09.5

10.010.511.0

00 01 02 03 04 05 06 07 08 09

(Percent)

Oct. 200910.2%

13U.S. Department of the Treasury, Financial Management Service, A Citizen’s Guide to the Financial Report of the United States Government (2008), at 7.

U.S. Government Accountability Office, The Federal Government’s Long-Term Fiscal Outlook: Fall 2009 Update (GAO-10-137SP, 2009), at 5.

15Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (January 23, 2008), Charts at 13.

16U.S. Government Accountability Office, Saving Our Future Requires Tough Choices Today (GAO-08-465CG, January 14, 2008), at 5

17U.S. Government Accountability Office, Saving Our Future Requires Tough Choices Today (GAO-08-465CG, January 14, 2008), at 6

Why the Fiscal Gap?• Aging of American

• Health Expenditures

18

Congressional Budget Office, Presentation to The Group of Thirty “Exit Strategy” for Fiscal Policy (December 4, 2009), at 11.

20Jonathan Barry Forman & Yung-Ping [Bing] Chen, Optimal Retirement Age, in New York University Review of Employee Benefits and Compensation—2008, Volume II, Chapter 14 (2008).

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22Jonathan Barry Forman & Yung-Ping [Bing] Chen, Optimal Retirement Age, in New York University Review of Employee Benefits and Compensation—2008, Volume II, Chapter 14 (2008).

23U.S. Department of the Treasury, Financial Management Service, Financial Report of the United States Government (2008), at 122.

24Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (January 23, 2008), Charts at 12.

25Congressional Budget Office, Growth in Health Care Costs (January 31, 2008), Charts at 8.

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security

(percentage of GDP)

    

Congressional Budget Office, The Long-Term Budget Outlook (June 2009), at 12 (Box 1-2).

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SS Unfunded Obligations(Present values as of January 1, 2008; trillions of

dollars)

Present value

As a % of future payroll

As a % of GDP

Over the infinite horizon

$13.6 3.2 1.1

Over the next 75 years

4.3 1.6 .6

2008 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Table IV.B6.

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Medicare Unfunded Obligations(Present values as of January 1, 2008; trillions of

dollars)

Present value

As a % of HI taxable payroll

As a % of GDP

Over the infinite horizon

$34.4 6.1 2.6

Over the next 75 years

12.4 3.4 1.6

2008 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, Table III.B10.

29U.S. Department of the Treasury, Financial Management Service, A Citizen’s Guide to the Financial Report of the United States Government (2008), at 8.

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Clearly Revenues Will Be Needed in the Future

• Tax Expenditures• What Is the Best Tax Base?

Federal Revenues by Source, 1940-2014 (Millions of dollars)

Fiscal Year Individual Income

Taxes

Corporate Income

Taxes

Social Insurance

and Retirement

Receipts

Excise Taxes

Other Total Receipts

1940 892 1,197 1,785 1,977 698 6,548

1960 40,715 21,494 14,683 11,676 3,923 92,492

1980 244,069 64,600 157,803 24,329 26,311 517,112

2000 1,004,462 207,289 652,852 68,865 91,750 2,025,218

2008 1,145,747 304,346 900,155 67,334 106,744 2,524,326

2014 estimate 1,612,672 420.238 1,166,609 79,021 201,584 3,480,124

Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009), at Historical Tables (table 2.1) .

Figure 1 Percentage Composition of Federal Receipts by Source: 1940-2005

0

10

20

30

40

50

60

1940 1950 1960 1970 1980 1990 2000

Year

Perc

ent

Individual Income Tax

Corporation Income Tax

Social Insurance and RetirementReceipts

Excise Taxes

Other

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Principles to Guide Tax Reform Legislation

• Distribution matters– A just distribution of economic resources

• Progressivity• Taxing earnings and investments

– Intergenerational justice/ Deficits

• Behavioral consequences matter– Encourage work and savings– Marriage penalties and bonuses– Keep effective tax rates as low as possible– Growth and a stronger dollar

• Simplification

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Tax Base• Income

• Consumption

• Earnings

• Wealth

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Top 10 Income Tax Expenditures, 2009 (Billions of Dollars)

Health insurance exclusion $168

Mortgage interest deduction 101

401(k) plans 51

Charitable contrib. (other than health & education)

47

Accelerated depreciation 44

Capital gains (except timber, iron ore, coal) 55

Deductible nonbusiness state and local taxes other than on houses

33

Employer plans 46

Step-up of basis at death 37

Capital gains exclusion on homes 342009 Federal Budget, Analytical Perspectives, Chapter 19, Tax Expenditures, Table 19-3

36Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009).

37Office of Management and the Budget, A New Era of Responsibility: Renewing America’s Promise (2009).

How an Integrated Tax & Transfer System Would Affect a Single Parent with 2

Children ($2,000 Personal Tax Credits, $2,000 per Worker Credits, and 20 & 35% Tax Rates)

Pre-transfer earnings

Plus personal tax

credits

Plus worker credit

Less tax imposed

After-tax income

0 $6,000 0 0 $6,000 $10,000 $6,000 $2,000 $2,000 $16,000 $20,000 $6,000 $2,000 $4,000 $24,000 $50,000 $6,000 $2,000 $10,000 $48,000 $100,000 $6,000 $2,000 $27,500 $80,500 $200,000 $6,000 $2,000 $62,500 $145,500

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How an Integrated Tax and Transfer System Would Affect a Single Parent with Two Children ($2,000 Universal Grants, $2,000 per Worker Credits, and 20 and 35 Percent Tax Rates)

$0

$25,000

$50,000

$75,000

$100,000

$0 $25,000 $50,000 $75,000 $100,000

Pre-transfer earnings

Post

-tax

, pos

t-tr

ansf

er

inco

me

Pre-transfer earnings

Post-tax, post transferincome

Consumption Tax Options

• Progressive Personal Consumption Tax

• Subtraction method Value Added Tax– Treasury Department proposal for

Business Activity Tax (BAT)

• Credit-method (European style) VAT

• National retail sales tax (RST)

Charles E. McClure, Jr., Why the United States Needs a Value Added Tax (2009).

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Conclusion• President needs 60 votes in the U.S. Senate

– The whole tax and benefit system is in play• And will be in play for years

– The lobbyists will be tripping over each other

• Change is almost always incremental

About the Author• Jonathan Barry Forman (“Jon”) is

– the Professor in Residence at the Internal Revenue Service Office of Chief Counsel, Washington, DC, for the 2009-2010 academic year;

– the Alfred P. Murrah Professor of Law at the University of Oklahoma College of Law, teaching tax and pension law; and

– the author of Making America Work (Washington, DC: Urban Institute Press, 2006).

• Prior to entering academia, Professor Forman served in all three branches of the federal government. He has a law degree from the University of Michigan and master’s degrees in both economics and psychology.

• Jon can be reached at jforman@ou.edu, 405-325-4779• Slides, etc. at www.law.ou.edu/faculty/forman.shtml

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