Tax Reform Isn’t Just About Revenue but Health Insurance, Housing, and More

This post originally appeared on TaxVox.

Taxes aren’t just about raising money for government. Policymakers engaging in tax reform must recognize how their decisions can disrupt markets for a wide range of economic activity, including healthcare, housing, and charitable giving. Some of those behavioral reactions may be secondary and unintended, but they can’t be ignored.

The Tax Policy Center has described some of the potential impacts of President Trump’s tax ideas on charitable giving and in the way businesses organize themselves. But it’s worth looking at two other examples—health insurance and homeownership—to see how tax changes can affect economic behavior. In both examples, tax reform can improve efficiency and equity, but only if it is well designed.

Employer-provided Health Insurance.

In a recent press conference, Treasury Secretary Steven Mnunchin and Director of the National Economic Council Gary Cohn implied that Trump’s tax plan could limit existing tax breaks for employer-sponsored health insurance (ESI). It would be one of a long list of tax preferences that Administration may target.

But any significant cut in subsidies for ESI could lead employers to reduce or even eliminate health insurance as part of employee compensation. The effects of such a decision could be substantial and most likely change the way people get health insurance. Tax reform must be designed with regard to its effects on subsidies offered through the Affordable Care Act or the House’s recently passed replacement.

For many years, health policy experts have suggested replacing the ESI exclusion with a tax credit. But the ACA and the House bill, and their related costs, largely depend upon retaining the ESI exclusion while adding subsides for those who buy outside the employer market.

The ACA’s exchange subsidy is larger for many employees than the value of their exclusion. Thus, employers already have some incentive to drop ESI coverage, send employees to an exchange, and share the net savings. Yet, so far, few have done so in part due to uncertainty about the future of the ACA and the reluctance of managers to give up their existing coverage. It is not clear how employers would respond to tax reform under the ACA or the House’s credits, which are less generous but in some cases more flexible.

Tax Subsidies for Housing

Although Cohn insists that “homeownership would be protected” under Trump’s tax plan, the Administration is considering several proposals that would significantly reduce incentives to buy housing.

Here are just three examples: Lowering tax rates would make the mortgage interest deduction less valuable. Eliminating property tax deductions as part of a repeal of the state and local tax deduction could raise taxes for homeowners who itemize. And doubling the standard deduction would significantly reduce the number of taxpayers taking deductions for mortgage interest.

In this new world, renters would increase in numbers and the number of homeowners would decline.

Like the exclusion for employer-provided health insurance, the tax subsidies for homeownership are both inefficient and inequitable. They provide an incentive mainly to those who need it least because the benefits are concentrated among those with higher incomes.

While it might make sense as a matter of tax policy to give middle-income individuals a higher standard deduction in lieu of the opportunity to itemize expenses, does it make sense as a matter of housing policy to leave a mortgage interest deduction concentrated on a select few taxpayers, largely with incomes well above average? And to what extent should equity owners, who still maintain an incentive to own homes, as opposed to taking out their equity and putting it into a saving account, be favored relative to borrowers? After all, younger and wealth-constrained, households are the ones most in need of borrowed funds to own their first homes, and they already have a far smaller share of total societal wealth than they did a generation ago

Providing some alternative incentive, such as to new homeowners, might help address some of these housing policy issues.

My concerns are not intended to throw cold water on tax reform. But they are a warning about the importance of doing it right.

Tax subsidies for health insurance and homeownership do need reform, but policymakers must ask themselves whether their new tax system creates the right set of incentives for the right people and integrates well with spending programs aimed at the some of the same objectives. They must also be sure to adjust as necessary to avoid undesirable behavioral responses. If they don’t, they may weaken or even destroy the benefits of reform.


Replacing the Individual Mandate to Buy Health Insurance: A First Step to Compromise

This post originally appeared in TaxVox.

The Trump Administration and congressional Republicans remain stalemated over how to “repeal and replace” the 2010 Affordable Care Act (ACA). One major problem: The House approach in the American Health Care Act (AHCA) is highly unlikely to pass Congress when it increases the number of uninsured by 23 million, as estimated by the Congressional Budget Office. Real reform needs a better set of building blocks. Here I address one of those building blocks: how to replace the ACA’s individual mandate in a way that satisfies both Democratic goals for coverage and Republican concerns that government shouldn’t mandate what citizens must buy. What is the alternative? Simply make some existing government benefits, particularly tax benefits, conditional upon buying health insurance.

Such a step could also be made at least as progressive as the ACA’s mandate, which would please Democrats. And it would replace the use of a whole new penalty tax structure surrounding the ACA’s mandate, a step that should please Republicans.

Fair and efficient reform of ACA requires recognizing the logic behind individual responsibility to purchase insurance, an idea long favored by many researchers and public officials across the ideological spectrum. If government is going to support those in need, whether through Medicaid, uncompensated care, or, under some new government subsidy, how should it treat those who don’t buy health insurance even if they have the financial resources to do so?  Equal justice suggests that a household making, say, $50,000 but effectively paying $10,000 to buy insurance—for instance, through lower cash compensation when receiving employer-provided insurance—shouldn’t have to subsidize other households with the same income but who don’t buy insurance.

That problem arises whenever government safety nets protect those who don’t insure against future needs but becomes particularly acute in health care when, as both Democrats and Republicans have now accepted, health insurance companies cannot exclude people with “pre-existing” conditions. Without some individual responsibility requirement, what is there to prevent people from going without insurance until they turn ill?

Democrats want to keep some requirement for individual responsibility to maintain the ACA’s coverage expansion. But why can’t Republicans find an acceptable alternative?

It’s simple math. Since adding millions to the roles of the uninsured seems politically unacceptable, the alternatives are to increase government benefits and the taxes needed to support them, or impose an even higher unfunded mandate on providers to care for the uninsured. Some commentators already believe that enactment of a House-like bill would eventually result in a universal system like Medicare for all, an unsatisfactory outcome for Republicans.

We are left with this: The federal government now spends about three-tenths of its entire non-interest budget on health care, and the share is increasing rapidly. In this expensive healthcare world, government supports should be targeted toward those who need help the most.

While the ACA’s mandate moves in the direction of establishing equal treatment of those with equal ability to buy insurance, it levies a penalty for most people that is far lower than the cost of insurance. According to a calculator provided by the Tax Policy Center, the 2016 penalty was $991 for a single person making $50,000 or $2,085 for a family of four. By contrast, the IRS indicates that an average “bronze” premium insurance policy would cost several times more: for an individual, about $2,700, and for a family of four, $10,700.

Making purchase of health insurance a condition for receiving other government benefits removes the philosophical and, for some, constitutional hang-up over whether government should mandate that we buy something. Instead, Congress could simply make health insurance a condition for opting to take some other benefits such as standard deduction, itemized deductions, or child credit. If we can get some more permanent agreement on some individual responsibility payment, the IRS can start to adjust withholding by employers for employees who don’t have employer insurance or declare otherwise that they have insurance. This would reduce end-of-the-year problems in collecting money from people who may not have any easy way to pay a penalty.

While some also suggest allowing insurance companies to charge higher premiums for those who buy insurance only when they get sick, that penalty is likely to be either too low to be effective or too high to be affordable by those who only seek insurance once sick.

In sum, any replacement structure for the ACA requires solid building blocks. Repealing and replacing the individual mandate with a conditional limit on the receipt of other government tax benefits offers one possibly bipartisan way to expand coverage, save government costs, and improve tax administration. To it, of course, must be added a subsidy system for those with too little income to afford insurance. The combination can be made as progressive or more progressive than the ACA. As noted, however, inattention to a requirement for individual responsibility will in the long run probably only add to the load that must be supported by the building block of government subsidies.


A Debt Straightjacket or a Misdiagnosed Disease?

Noting rising public and private debt across the developed world, International Economy magazine recently asked a group of economists, including me, “Has the world been fitted with a debt straightjacket?” Below is the response I gave. You can see the full range of responses given by others here (PDF)

A straightjacket, yes, but debt defines its features poorly. Debt is merely one symptom of a disease that has vastly restricted the ability of developed nations to respond to new needs, emergencies, opportunities, and voter interests. The disease: the extraordinary degree to which past policymakers have attempted to control the future—building automatic growth or growing public expectations into existing spending and tax subsidy programs while refusing to collect the corresponding revenues required to pay for them.

In Dead Men Ruling I show how this leads to a “decline in fiscal democracy”—the sense by officials and voters alike that they have lost control over their fiscal destiny. Though the degree and nature of the problem varies by type of government and culture, research so far in the U.S. and Germany, two countries with greater fiscal space than most other developed countries, confirms this historic shift.

We must understand how we got here if we ever expect to get a cure, since defining the problem by the debt symptom has led mainly to periodic deficit cutting that leaves the same long-term bind, frustrating voters and officials alike while increasing the appeal of anarchists and populists.

For most of history, nations with even modest economic growth wore no long-term fiscal straightjacket. Even with the debt levels left at the end of World War II, economic growth led to rising revenues, while most spending grew only through newly legislated programs or features added to programs. Typically existing programs were expected to decline in cost, e.g., as a defense need was met or construction was completed. Until recent decades budget offices did no long-term projection, but if they had, they would have revealed massive future surpluses over time even when a current year revealed an excessive deficit. Year-after-year profligacy was still a danger, but it wasn’t built into what in the U.S. is referred to as “current law.”

Today, rising spending expectations are built into the law through features such as retirement benefits that rise with wages, expectations that health care spending will automatically pay for new innovations, and failure to adjust for declining birth rates and the corresponding hit on spending, employment and revenues. At the same time, officials fail to raise the revenues required to meet, much less fund, those laws or voter expectations.

A rising debt level relative to GDP is merely one symptom. Reduced ability to respond to the next recession or emergency is another, while the increasing share of government spending on consumption and interest crimps programs oriented toward work, investment, saving, human capital formation, and mobility.

Politically the chief budget job of elected officials turns from give-aways to avoid growing surpluses to take-aways that renege on what the public believes is promised to them. Economic populists, fiscal hawks and doves alike, don’t help when their fights over short-run austerity ignore the fundamental long-term disease.

The bottom line: flexibility, not merely sustainable debt, is required for any institution—business, household, or government—to thrive.


The Trump Administration Dilemma on Tax Reform

This post originally appeared on TaxVox.

Q: Since the modern federal income tax was created in 1913, how often has Congress enacted a revenue-neutral income tax reform that significantly expanded the tax base and lowered rates??

A: One. In 1986.

It is no wonder that the Trump administration—like others before it—is struggling with broad and systemic tax reform. To better understand why, think of tax legislation in three distinct flavors: tax cuts, tax increases, and revenue-neutral changes.

Most income tax bills cut taxes. The reason is obvious. Elected officials like to give something to voters rather than take something away from them.

Since the large tax increases required to finance World War II, most revenue bills reduced taxes, particularly in the period up through 1981. Significant reductions in defense spending as a share of the economy, along with inflationary increases in incomes that pushed people to pay higher individual income tax rates, made legislated tax cuts possible during what I call the Era of Easy Finance.

In a few cases, Congress did raise income taxes. Tax historians Joseph Thorndike and Elliott Brownlee have shown that almost all major income tax increases came about as a result of war. Others, generally raising annual revenues by well less than 1 percent of GDP, have been enacted, for instance, as part of several deficit reduction agreements between 1982 and 1997.

Broad-based and systemic income tax reform that keeps revenues roughly the same as current law requires a tremendous amount of work, largely because it means broadening the tax base by identifying which popular tax subsidies, now costing more than $1 trillion annually, should be targeted for elimination.

Less broad-based but still systemic reforms are also possible. Outstanding modern examples are the codification effort of 1954 and the 1969 reform best known for addressing tax issues surrounding foundations and charities.

As economic coordinator of the Treasury’s 1984 study that led to the Tax Reform Act of 1986, I remember how difficult it was for Treasury and Joint Committee on Taxation staffs to draft legislation and to estimate cost and distributional effects for those proposals. Increasing taxes on some to pay for tax cuts for others requires tax writers to agree on principles to guide and justify their actions. The political aspects of tax reform, building a political coalition to push to see these principles enacted, are even more difficult than the technical concerns.

Tax reform of the revenue-neutral variety is much harder than merely cutting taxes. To cut taxes, lawmakers simply tally a set of wants, perhaps pare them down to fit within a specified amount, and leave the financing bill for current tax cuts to future generations of unidentified taxpayers.

Finally, the design of any systemic reform must acknowledge the economic and political environment of its time. The 1986 Act, for instance, took advantage of bipartisan concerns over tax shelters, President Reagan’s focus on high tax rates, Democrats’ objections to the rising income taxation of the poor, and social conservatives’ efforts to reverse the rising burden being placed on families with children. Deficits were perceived to be a problem, though a smaller one than today in part because Congress had raised taxes and cut spending in the 1982 and 1984 budget agreements and in the Social Security Act of 1983.

President Trump and his team have promised to cut tax rates for all businesses and for the middle class, while not increasing the deficit. They can’t get there by taxing the poor. Even if they assume greater economic growth, it’s not going to be enough to pay for the historically large tax cut provisions. So what’s left?

Some seem to want simply to throw in the towel on revenue neutral tax reform and just cut taxes instead. But $1.3 trillion in additional spending is already built in for 2026 (largely due to rising interest costs and increased spending on Social Security, Medicare, and Medicaid). This is far more than the $850 billion in additional taxes projected to be collected for that year due to a growing economy. How will Congress and the president cover that existing shortfall, even before they think of more tax cuts?

That’s the box the Administration is in. And it is why tax reform is no easier than health care reform. Avoiding big new revenue losses requires systemic reform, such as increasing taxes on individuals to offset business tax cuts. Or engaging in true budget reform that includes scaling back on popular programs. Those are the requirements of our time, like them or not, and while briefly they might be ignored politically, over the longer run they can’t be dodged as a matter of either economics or arithmetic.


How Both Public Tax Reform and Private Sector Initiatives Can Strengthen Charities

This post originally appeared in TaxVox.

In the March and April 2017 print editions of the Chronicle of Philanthropy, I proposed both a public and a private sector initiative for strengthening charities. These included improved tax policies as well as steps charities could take independently of any legislation. These initiatives aim to increase charitable giving of income, wealth, and time.

My organizing principle was simple: First, make tax subsidies more effective and efficient. Second, improve the way charities market themselves. Neither Congress nor the charitable sector has ever approached either task in a comprehensive way. The articles are here and here, with permission of the Chronicle.

Here, briefly, are my suggestions:

What government can do:

  • Allow all taxpayers—even current non-itemizers—to claim a deduction for contributions above some minimum amount.
  • Extend the deduction to gifts made by April 15 or filing of one’s tax return—similar to the extended contribution date for Individual Retirement Account contributions– rather than December 31 of the previous calendar year.
  • Create a better donation-reporting system to IRS to reduce tax non-compliance, with a reward of an extra deduction for those donations; the improved tax compliance should more than pay for the extra reward.
  • Make it easier for individuals to make donations from their IRA accounts.
  • Reduce and simplify the excise tax on foundations.
  • Encourage charitable bequests, especially if the estate tax is cut or repealed.

What charities can do, independently from government:

  • Create a national campaign to promote giving, such as:
    • Tell simple but powerful human-interest stories extolling generous people.
    • Help donors identify worthy programs by promoting access to useful sources of information on each charity.
    • Encourage people to give to charity when they settle disputes.
  • Help people understand better their potential to give out of wealth, not just income, and to leave lasting legacies:
    • Run endowment campaigns.
    • Encourage wealth advisers to promote charitable giving.

Today charities feel under siege. They fear they are about to lose direct government support if Congress cuts domestic spending that funds the specific programs they run. And they worry that lawmakers will trim tax benefits for charitable giving by individuals and firms. Their concerns are legitimate but, in truth, over the many decades I have worked with charities on public policy issues, their advocacy has nearly always felt defensive.

Charities can easily become collateral damage from policies that are not aimed directly at them. Congress won’t decide broad issues such as size of government, tax rates, limits on tax incentives, or the share of revenues that should come from income taxes (the only tax where there is a charitable deduction) solely or primarily based on their effect on the charitable sector.

Thus charities must think longer-term as the nation is struggles to define a modern set of public policies and societal goals relevant to 21st century needs and opportunities. My suggestions are intended to extend well beyond any current political battle, no matter which party controls government at any point. Their goal is to strengthen the charitable sector, by improving both government incentives and the outreach and self-examination by non-profits themselves.

Fighting to maintain the status quo is not a strategic option. Nor should every charity expect to come out unscathed in this rapidly changing environment. But the US is facing important choices as it decides the direction and size of government in the Trump era. That debate ought to include a broad look at charities in this new environment and whether that includes strengthening, though reforming, the role of charities in American life.


How the Fight over Symbols Prevents Health, Trade, Immigration and Tax Reform

This post originally appeared on TaxVox. 

President Trump came into office promising to repeal the Affordable Care Act, abandon key multinational trade agreements, build a wall and send immigrants home, and reform the tax code. Many Democrats have sworn to oppose him at every turn. On the first three items, he has already faced obstacles or stalemate and even temporarily left the battleground. But are these debates really about substantive reform that improves people’s lives? Or mainly over capturing symbols that appeal to each party’s base? Those goals aren’t the same.

Reform defies easy party or ideological labels because it often focuses not on bigger or smaller government but fixing poorly-functioning operations, establishing greater equity among households, or adapting to new circumstances. With health, immigration, trade, and tax policy the need for constant real improvement conflicts with important, but often-counterproductive, fights over political symbolism.

Health Reform. When the Affordable Care Act (ACA or Obamacare) passed the Senate, backers knew it had flaws. They hoped to fix them later in the legislative process, but the death of Sen. Ted Kennedy cost Democrats their filibuster-proof majority in the Senate and made the fixes or amendments requiring a new Senate vote virtually impossible. As a result, the healthcare community and households continue to grapple with an imperfect environment: Gains from expanded insurance coverage have been offset by slower than expected take-up rates, especially among young adults, for ACA marketplace policies, ongoing uncertainty about Medicaid expansions, and failure to come to grips with the full impact of health cost growth, often outside of Obamacare, on the federal budget.

Congress and President Trump have a chance to repair those problems, but both parties find themselves in a box. Republicans can’t accept any reforms that allow Democrats to claim “Obamacare” is being preserved, while many Democrats can’t swallow changes that acknowledge the ACA’s failures.

Trade Reform. Trade is another case where political symbolism impedes needed change. No doubt, our trading partners at times violate the spirit and even treaty letter of “fair” trade (so does the US), but trade agreements are the very vehicle for limiting such violations. Rather than repairing these understandings, political symbolism demands they be torn up or abandoned. Thus, instead of reviving and revising the Transpacific Partnership, which might have enhanced US trade in Asia, the Trump Administration has scrapped it.

Any successful trade agreement must strengthen rather than weaken international commerce if it is to promote economic growth without raising consumer prices. But trade debates occur on treacherous political ground. Any shift in trade, no matter how good or bad, almost inevitably reduces demand for some US-made products and hurts the workers producing those goods, thereby creating a new group of populists who will cry “foul” that the President and Congress have once again abandoned workers.

Immigration Reform. People suffering from persecution, hunger, or lack of human rights will try to escape those horrors and find new opportunity. So it has always been and will always be. Borders are porous enough that there are tens of millions of immigrants, legal and illegal, in the United States and much of Europe. Meanwhile, immigrants grow as a share of developed nations’ total populations, partly due to relatively low-birthrates in the existing populations. We can reduce opportunities for legal entry, step up border patrols, build walls, and send even more people back to their prior country of residence. But none of those actions really address the basic economic and social forces at play, while temporary symbolic political victories leave millions of families fearful of breakup, reduce domestic output by immigrant workers, and hurt America’s image as the home of freedom for people around the globe.

Tax Reform. In taxation, the symbolic fights almost always center on the size of government and progressivity. Yet many of the tax code’s real problems are that it is inefficient, complex, and treats those with equal incomes unequally and inequitably. The Tax Reform Act of 1986 neatly focused on the latter issues by making no significant change in either revenues or progressivity. But even in its early stages, the debate over a 2017 tax reform has already been muddled by a cacophony of mutually inconsistent goals: Reduce tax rates for multinational corporations and cut taxes for the middle class while not increasing the deficit or raising anyone’s taxes.

As long as lawmakers fight mainly over symbols rather than substance, they are unlikely to achieve many real improvements in policy. And tax reform will follow along the path down which health, immigration, and trade reform already seem headed.


Before We Reform Tax Policy, We Need to Know What Is Working

This post originally appeared on TaxVox

Med_Capitol

Congress and President Trump are embarking on what is likely to be a major rewrite of the federal income tax code. Yet, neither they nor anyone else knows whether the hundreds of tax preferences embedded in the law accomplish their stated purposes.

Federal agencies routinely collect and assess evidence of the success—or failure—of spending programs. But the IRS is an outlier. Although it manages a broad range of federal programs through the tax code, including housing, health, wage subsidies, and retirement, it has made little effort to evaluate its portfolio.

These policies, sometimes called tax expenditures, add up to more than $1 trillion per year and comprise approximately one-quarter to one-third of combined spending and tax subsidies. Yet the IRS appears to do less than any other agency to gather evidence on the efficacy of the programs it runs.

Years ago, the Office of Management and Budget instructed executive branch agencies to measure performance. Many did so. But the IRS essentially said it didn’t have the information, and did not comply.

Over the years, government has tried repeatedly to gather solid evidence to justify new and existing government policies. Success has been limited. It has tried “Planning, Programming, and Budgeting,” and “Zero-Based Budgeting.” Congress enacted the Government Performance and Review Act (GPRA). Speaker of the House Paul Ryan (R-WI) and Senator Patty Murray (D-WA) advanced this goal recently through the creation of the Commission on Evidence-Based Policymaking.

The National Academies of Science has appointed committees to investigate both how to improve the quality of economic evidence and encourage its use to inform policy. I was fortunate enough to chair one of those committees. Jason Furman, President Obama’s last chair of the Council of Economic Advisers, recently noted how new evidence advances our ability to design social policy.

Overall, success has been mixed. But rarely have we learned less than at the IRS. My purpose is not to assess blame. Congress has given the IRS far more responsibility than it can possibly manage, even as it has slashed its budget.  That is not likely to change any time soon. But even in that environment, there are ways the IRS can develop and present economic evidence on the programs it runs.

I have two simple suggestions. Both require the Commissioner to place greater priority on generating evidence.

First, the IRS should report administrative information to Congress on each program or subprogram it operates. It should describe how tax subsidies are distributed by taxpayer income and geographical location.  It should report on noncompliance or on gaps in its ability to enforce the law in each program. To assess a program adequately, we need solid evidence on how well IRS can administer it.

Beyond basic administrative information, the agency could at least on a rotating basis start to evaluate program benefits and costs.

Second, the IRS commissioner should hire a Chief Evaluation Officer who would  work closely with the Taxpayer Advocate to teach and encourage staff to make better use of the tools that generate such evidence. Demetra Nightingale, who recently served in this capacity for the Labor Department, says these tools were most successful when staffers believed they could help them do their jobs better, and not simply the result of some top-down command.

The most successful of modern reforms, the Tax Reform Act of 1986, succeeded in eliminating some tax breaks and deterring some shelters. But even it added new complexity to the code. If Congress is going to look seriously at the scores of subsidies in the current code, it needs better evidence about which achieve their goals and which can be properly administered. To do that, Congress needs to give the agency the resources it needs to properly evaluate the programs it manages. And the agency needs to do more analysis with whatever resources it has.

Photo courtesy of Flickr Creative Commons.


Did the Financially Insecure Secure Donald Trump’s Victory?

 

 

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In a classic case of Monday-morning (or Wednesday-morning) quarterbacking, many of us tend to seek one simple explanation for why Donald Trump won the recent presidential election. New analysis from some of my colleagues at the Urban Institute shows that the real reasons are more complex and transcend sound bites.

As part of our Opportunity and Ownership Initiative, Diana Elliott and Emma Kalish have assessed ongoing election narratives with some on-the-ground facts and an interactive map. They compare county-by-county elections results with various financial and demographic characteristics of voters. Interestingly, Diana and Emma conclude that financial insecurity did not drive voting preferences.

In fact, Hillary Clinton won just 4 of the 55 counties (or county equivalents) whose residents had the highest average credit scores (720 and above). High credit scores imply bills paid promptly and the type of financial stability that comes with paying off a mortgage over time. Clinton did win the 11 counties with the lowest scores.

Race and education were strong factors: generally speaking, white consumers were more likely to vote for Trump, those with bachelors’ degrees or higher to vote for Clinton.

These results provide information not only about voting patterns but about whether different policy initiatives would help those who feel ignored or left out by government, another part of the post-election debate. Further research might also reveal whether Trump appealed to people living in regions that had suffered some decline in security or population, even if voters’ relative financial standing in November 2016 was average or better.

If you access the interactive map yourself, you can do your own analysis of many interesting—and sometimes surprising—factors and see results for particular counties and regions.