Avoiding the Extremes on Either Side

 

Not only is Washington politics already hyper-partisan, but both parties are continuing to move to even greater extremes, see here and here.
Here are two examples of extreme positions now being espoused by major elements of one or the other of the two parties:

  • Single payer healthcare. The failure of the GOP effort to repeal the Affordable Care Act this past summer means that (the goal of) universal healthcare is here to stay. The ACA expands access to healthcare but does nothing to control costs. Single payer, Medicare for All, would control costs but then we end up with socialized medicine. The only way to establish a cost efficient free market healthcare system is to remove, or at least limit, the tax exemption for employer provided care and to set up high deductible catastrophic care supplemented by health savings accounts to pay for routine expenses. This would compel everyone to pay close attention to the cost of their own healthcare.
  • Tax cuts instead of tax reform. Tax reform, i.e. lowering both corporate and individual tax rates, paid for by closing loopholes and shrinking deductions, is an excellent way to speed up economic growth and thereby create more and better paying jobs. But it is imperative to do this in a revenue neutral manner, i.e. without increasing our annual deficits. Our debt (the public part on which we pay interest) now stands at 77% of GDP, the highest it has been since the end of WWII, and is predicted by the Congressional Budget Office to keep getting larger without major changes in public policy.

Conclusion. The U.S. badly needs a more cost efficient healthcare system and a simpler and more efficient tax system. But there are right ways and wrong ways to do both of these things.  Single payer healthcare and (unpaid for) tax rate cuts are the wrong way to proceed.  In each case, no action at all is much better than getting it wrong.

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New Urgency in Deficit and Debt Control

 

The general theme of this blog is major fiscal and economic issues facing the U.S. such as slow economic growth and huge debt. But our currently low unemployment rate of 4.4% and several trends, here and here, suggest that economic growth may already be starting to pick up.
This means that our huge debt, now 77%, for the public part on which we pay interest, the highest it has been since right after WWII, is now one of the very biggest problems facing our country.
Consider:

  • The only practical way to “solve” our debt problem (so to speak) is for each year’s annual deficit to be less than economic growth for that year. When this happens, then the debt will decrease as a percentage of GDP. If this pattern were to hold year after year, then debt would continue to shrink. This is exactly what happened from 1946 until about 1980 but since then the pattern has reversed and the debt has increased. It has grown especially fast since the financial crisis in 2008 (see chart).
  • The Fiscal Year 2017 deficit is $700 billion out of a total GDP of $20 trillion, which computes to 3.5% of GDP, well above the 2% annual growth of GDP for the 2017 FY. This means that our debt got worse in 2017.
  • Congress has already approved $15 billion in disaster relief for Hurricane Harvey. Now the White House is asking for $29 billion more ($12.8 billion for new disaster relief, especially for Puerto Rico, and $16 billion for the National Flood Insurance Program).  Congress has also approved a big increase in the Defense Budget, to $700 billion, for the 2018 FY.
  • Congress will soon be approving a budget for 2018 and then start working on a tax reform package. Given the likely increases in both military spending and disaster relief described above, it is now even more important for the new budget to show overall spending restraint and for the tax reform package to be revenue neutral.

Conclusion. Let’s hope that Congress gets the message about the new urgency of our debt problem and acts accordingly!

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Fundamental Principle for Tax Reform II. What to Avoid

 

In my last post I made the case that the two fundamental principles for effective tax reform are:

  • Faster economic growth, to create more jobs and bigger pay raises.
  • Revenue neutrality, since more debt at this time is just too risky.

And then I went on to suggest the specific changes in the tax code which would achieve these goals:

  • Reducing the corporate tax rate to approximately 20%.
  • Full expensing for business investment replacing depreciation spread out over many years.
  • Simplification of rules for individuals such as fewer tax rates and fewer credits.
  • Achieving revenue neutrality by eliminating as many deductions as necessary to pay for the above tax rate cuts.

There are different ways to accomplish all this and I recently described one attractive plan put together by the Tax Foundation. The Republican Congressional Leadership (Big Six) has proposed a different plan which has been analyzed by the nonpartisan Committee for a Responsible Federal Budget.  Unfortunately CRFB concludes that this plan will cost $2.2 trillion over ten years in lost revenue.  But it could be modified in the following ways to become revenue neutral:

  • The mortgage interest deduction is maintained but limited to one dwelling and $500,000, down from the current limit of two homes and $1 million.
  • The tax exemption for employer provided health insurance is limited. This not only increases tax revenue but also forces the 150 million Americans who receive health insurance from their employer to take an active role in holding down the cost of healthcare.
  • Drop the proposal of establishing a maximum “pass through” rate of 25% for business owners. Any such proposal would be subject to wide spread abuse. Businesses would be benefitting from the full expensing provision above and their owners should pay taxes at the same rates as everyone else.
  • Keep the estate tax until annual deficits are greatly reduced. It only brings in $20 billion per year but every little bit helps.

Conclusion. These common sense changes in the Big Six plan would make it revenue neutral and still capable of achieving a significant boost to the economy.

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How to Achieve Sensible Tax Reform

 

Experts across the political spectrum agree that the U.S. tax code is a huge mess and needs to be reformed as well as simplified.  It is also generally accepted that lower tax rates will lead to faster economic growth.
As Congress turns its attention to tax reform, Senate Democrats have stated the basic principles which they would like to see included in any changes which are made:

  • Increase the wages of working families. This could be accomplished by lowering tax rates for all individuals across the board, paid for by eliminating (or at least shrinking) many of the personal deductions in the tax code. The approximately two thirds of all taxpayers who do not itemize deductions would then receive a tax cut, equivalent to a wage increase.
  • Promote domestic investment and improve middle class job growth. Lower tax rates will give businesses and entrepreneurs a bigger incentive to invest in business expansion and therefore grow the economy faster and create more new jobs.

  • Modernize our outdated business and international tax system. Our corporate tax rate at 35% is the highest in the developed world and, at the same time, produces below average revenue (see chart). Another reform would be to adopt business expensing (immediate tax write-off for new investment). Again, all such changes should be paid for by eliminating loopholes and shrinking deductions.
  • Any rewrite of the tax code must be deficit neutral. As important and valuable as tax reform is, it has to take into account our country’s most fundamental problem: our huge and rapidly growing national debt and therefore end up being deficit neutral overall.

Conclusion. The above principles, stated by the Senate Democrats, represent a sound approach to reforming the U.S. tax system. I hope that the Republicans are willing to recognize the validity of these proposals and include the Democrats in developing a bipartisan tax reform plan.

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The Need to Put Medicaid on a Budget

The GOP healthcare plan, both the House version and the Senate version, are highly imperfect. Yet they each do one thing which is badly needed. They put Medicaid on a budget. The current open-ended Medicaid program, whereby each state is reimbursed by the federal government for a percentage of its costs (the average is 53%), would be replaced by an annual per-capita payment which would increase only at the rate of inflation. It is estimated that the new per-capita budget would reduce federal Medicaid payments by about 25% after 10 years.


In order to get the federal debt under control, all three major entitlement programs, Social Security, Medicare and Medicaid, must be reined in and the current GOP plan would start doing this for Medicaid.
Reining in spending like this will force states to alter the way they regulate and administer Medicaid and the New York Times columnist Ron Lieber points out some of the challenges which will arise if Medicaid has to operate more efficiently:

Nursing homes. One third of people who turn 65 will eventually end up in a nursing home. Furthermore, 62% of nursing home residents cannot pay for nursing homes on their own. The average annual cost of a semi=private room is $82,000.
Home and community-based care. Medicaid is required to pay for nursing homes and may also pay for home and community-based care which is much less expensive and lets seniors stay in their own homes.
Optional services for low-income people and the disabled. Optional services besides long-term home care include dental care for adults, therapy for disabled children at school, prosthetic limbs and prescription drugs.

Conclusion. Changing Medicaid from open-ended funding to a strict federal budget which grows at the rate of inflation will put a large burden on state Medicaid administrators and require some difficult tradeoffs to control spending. But this is absolutely essential as a first step towards controlling the rapid increase of entitlement spending.

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An Emerging Democratic Agenda

 

I am just as personally embarrassed by President Donald Trump as most other people I know. He is rude towards other world leaders and especially our own allies.  His destructive behavior endangers even his own policy initiatives.  He was elected by blue-collar workers who feel left behind in today’s global economy.  But how can he possibly lead others in implementing policies to help even his most avid supporters?


What is the Democratic Party doing about this?  First of all, they are trying to stop acting so elitist toward the working class.  But more fundamentally a new progressive social agenda apparently is emerging, here and here.  It has many attractive features but there is one big thing missing, namely fiscal responsibility:

  • A “public apprenticeship” jobs program. The idea here is to maintain the employment rate for prime-age workers without a bachelor’s degree at the 2000 level of 79%. This would require the creation of 4.4 million jobs, ideally at a living wage of $15 per hour plus Social Security and Medicare payroll taxes, and therefore at a wage of $36,000 per year. This would cost $158 billion per year.
  • A universal child allowance of $250 per month. This would cost $190 billion per year, although half could be offset by consolidating less-efficient existing programs. This would cut child poverty by 40%.
  • An expansion of the earned income tax credit. A family of four making $40,000 per year would get a tax credit of $6000 instead of the current credit of $2000. This would cost $1 trillion over ten years. The idea here is extra motivation to hold a job.

 

Conclusion. Who is opposed to creating millions of new living wage jobs to put the unemployed and underemployed back to work? Such a program would give our economy a huge boost.  Who is opposed to cutting child poverty in half (or doing even better)?  But how in the world would we make room for such new programs in the federal budget?  With $500 billion annual deficit spending already, we need to curtail federal spending, not increase it.

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Responsible Tax Reform II. The Trump Plan

 

Responsible tax reform will be highly beneficial for the U.S. economy because:

  • Economic growth will be speeded up by lowering tax rates on businesses, thereby encouraging more investment.
  • National debt will shrink because faster growth will produce more tax revenue. But this only works if the revised tax plan is revenue neutral to begin with.

The Trump tax plan, described here and here, has the following features:

  • three tax brackets, reduced from seven. Simplification like this is a good idea.
  • double the standard deduction. This puts more money in the pockets of the average tax payer who does not itemize deductions and is therefore a good idea.
  • repeal of the alternative minimum tax. This only affects wealthy people and should be retained, if necessary, to make sure that overall reform does not increase the deficit.
  • lower capital gains tax. This will encourage more investment but should not be included unless the overall plan is revenue neutral.
  • repeal of inheritance tax. This tax feature should be retained until our annual budget deficits are eliminated, i.e. until we achieve balanced budgets on an annual basis.
  • preserving deductions for mortgage interest and charitable contributions. The mortgage interest deduction should be greatly reduced from its current level of $1 million per residence. Wealthy taxpayers don’t need that much help. Raising the standard deduction will already help middle income taxpayers.
  • cutting the corporate tax rate. This is an excellent idea as long as its revenue loss is made up elsewhere. It will encourage multinational corporations to bring their overseas profits back home for reinvestment in the U.S.

Conclusion. The Trump tax plan has some good features as well as some poor ones. Reducing tax rates is a good idea.  But adding to annual deficits is a very bad idea.  With some effort it is possible to reduce tax rates in a revenue neutral way.

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