How to be Irresponsible

It's a bit rare that I cross post here but this post from Christopher Demuth is worth reading in its entirety.

In a nutshell, it exposes the loss of focus of both Keynesianism and supply side economics.  Both have been subverted by the political process into a force for moving consumption to today and costs to the future.  In effect, we have a political process that competes for how to be irresponsible as opposed to whether to be.

Which brings me to the current fiscal cliff debate, the perfect incarnation of the how to be irresponsible discussion.  On one side, we have the Democratic party which is asserting that tax increases on 2% of households and (small) unspecified future spending changes will be sufficient to avert the fiscal crisis we face.

On the other side we have the Republican party which is asserting that future unspecified (but larger) spending reductions are sufficient to address the crisis.  I mean, look at these plans in context.  Over the next decade, we plan to spend about $45 trillion and tax about $35 to $40 trillion.  And our tax and spending plans amount to a change of $2 trillion or so in total, a 2.5% change from the most unbalanced place we've ever been.  And that's DC's version of difficult choices.

And that's the debate...a debate about how to be irresponsible...about which irresponsible ideology will prevail.  Unfortunately, regardless of the outcome of the debate, the future is the same.  We run up debt until we can't anymore.  At that point, some combination of future taxpayers and asset holders get well and thoroughly screwed.

The Meaning of Words

It's one thing when false information is presented in opinion pieces, but when it's presented in news pieces, that's a horse of a different color.  For instance, we have this from Reuters by way of yahoo news.

WASHINGTON (Reuters) - U.S. Republican presidential candidate Mitt Romney said he thinks it is "fair" that he pays a lower tax rate on his investment income of $20 million last year than someone who made $50,000 annually.

Now, I strongly suspect that most readers would read this as asserting that the average taxpayer who makes $50,000 pays a higher federal tax rate than does Mitt Romney.  But of course, this isn't true.  Courtesy of the TPC, we can see that taxpayers in the $40,000 to $50,000 range average 12.1% in total federal taxes (excluding imputed corporate taxes) while taxpayers in the $50,000 to $75,000 range average 14.5%.  Asserting that people earning $50,000 pay more than Romney simply flies in the face of the numbers.

Or maybe the authors meant to argue there is some taxpayer who makes $50,000 who pays a higher rate than Romney.  This latter statement is almost certainly true but not, I think, a reasonable inference from the quoted paragraph.

Applying FICA tax to Mitt Romney

On another site on which I am a frequent participant, I was asked about the implications of applying the FICA tax to capital income.  It seems an interesting exercise so I did the calculations which I will repeat here.

Starting with the IRS SOI data from 2009 (the most recent year currently available), we can gather up the additional income that was reported and would be subject to a potential FICA tax on investment income.  This income totals to about $443 billion in 2009.  Were we to subject that income to the full employee side tax rate of 7.7% (6.2% for SS and 1.5% for Medicare), we'd get total taxes raised of about $34 billion.

Comparing this to total FICA taxes in 2009 of $890 billion according to the CBO suggests that applying FICA taxes to investment income would increase FICA tax receipts by a bit less than 4%.

But what of its affect on governor Romney?  Well, it would have raise his effective tax rate by 7.7 percentage points up to 21.8 percent.  So we can conclude that it would have made people feel better about governor Romney's taxes (maybe) but made little difference otherwise.

Well Worth the Read

This speech from Richard Fisher at the Dallas Fed is well worth reading in its entirety.  It speaks to both the current monetary situation and, at least in my view, the limitations of macroeconomic modeling.

It's worth remembering that a model is only good in the area in which there are historical observations.  We are no longer in that area.

Why Romney's Tax Rate is Lower Than Yours (Maybe)

So now that Mitt Romney has released another tax return, we're going to get a rehash of stories on the fact that Mitt Romney's tax rate is lower than the average American's.  But let's take a look at whether this is true; and, to the degree it is, why it's true.

To start, we'll use the TPC estimates of 2011 tax rates.  Now Mitt Romney's tax rate was reported to be 14.1%.  So how does that compare?  Well, first we have to choose what to compare it to. One approach would be to compare Romney's rate to the sum of the income and payroll tax rates.  It's clear that neither the corporate tax nor the estate tax can be discerned from Romney's tax return.  It's also true that Romney's FICA tax is unknowable from his return but we can assume that Romney's FICA tax is pretty close to zero as a percentage of his income.

So if we look at income plus payroll taxes by income group, we find that middle income taxpayers (the middle quintile of earners) have a lower tax rate than Romney (12.1% vs 14.1%) and the second quintile has a slightly higher rate (16.0% versus 14.1%).

So what accounts for the difference?  Well, many people have claimed that the difference is driven by "preferential rates on capital gains."  But this just doesn't seem to be true.  Taxation on capital gains is different from ordinary income in two ways.  One, it's taxed at a flat 15% and two, there is no FICA tax on capital income.  So let's pull these two things apart.

To look at the effect of the rate differential, let's just look at the effective federal income tax rate.  By this measure, Romney's effective tax rate is higher than every group of taxpayers below the 96th percentile, hardly lower than most Americans.

So what's accounting for the difference is the fact that FICA taxes aren't applied to capital gains and (for most of them) are capped at an income threshold.  But these two things have been true of FICA taxes for as long as they have existed.  So, in effect, the root cause of all of this is the fact that FICA taxes don't apply to capital income.  Nobody has proposed changing this and it has always been this way.

Just thought it worth pointing out.

False Unequivalence

So I'm normally a fan of Derek Thompson over at The Atlantic.  I quite often disagree with him but I think he's normally pretty good.  But here he's pretty awful.

Let's review.  He takes Governor Romney rightly to task for saying that "middle class" should be defined as having less than $250,000 in annual income.  But here's what you can find on the White House website.

Unless the House of Representatives takes action before January 1, 2013, taxes will go up on 114 million middle-class families. Nearly everyone in Washington agrees that’s a bad idea. That’s why President Obama is calling for -- and the Senate has already passed--  legislation that will keep the middle class from paying thousands of extra dollars next year.

So the President will reduce taxes on 114 million middle class families.  As it turns out, according to the census, there are only 118 million households in the US and 79 million family households.  So the most charitable view of the WH website is that the President has the same definition of "middle class" as does Governor Romney.  Of course, a less charitable view, which is what Derek applies to Governor Romney, would suggest that the President thinks he can reduce taxes for 130 percent of all family households in the United States.

There's no reason to defend Romney's statement as it's wrong.  But, at best, it's no more wrong that what's up on the WH website.  Either way, the selective outrage here is really crazy.

A Long Reply to Peter Orzag

Well, I don't get to post in the Washington Post but I do want to reply to Mr. Orzag's most recent column there.  Warning to all, this is going to be a long post as his is a long column with quite a lot of misrepresentations.

First, federal Medicaid spending is currently forecast to double by 2040, from 2 percent of gross domestic product to 4 percent. Under Ryan’s budget, it is projected to be cut in half over that period. This dramatic turnaround will supposedly occur by turning Medicaid over to the states through block grants. Anyone want to bet that will work? If states can’t find huge efficiencies in Medicaid, expect them to pressure the federal government to avoid the fanciful reductions in federal support assumed in the Ryan budget.

It's kind of interesting really.  This is nothing more than an argument that Mr. Orzag believes that Medicaid cannot survive on 3% per year increases in funding (which is what is in the Ryan budget) from the current baseline.  Mr. Orzag is entitled to his opinion and he may prove to be right but this hardly proves anything.  As I've written elsewhere, assuming the end to our slow growth period, as all forecasters have and assuming 1% annual efficiency in Medicaid spending, 3% growth in Medicaid is not a bad forecast over the next decade.  In the longer run, it may be worse but this is hardly the ridiculous assumption that Mr. Orzag assumes it to be.

Second, the Wisconsin congressman has specified $4.5 trillion in tax cuts, counting on massive rollbacks of tax breaks — such as the mortgage interest deduction — to pay for them. But he offers no details as to how to achieve such reductions, and most serious tax analysts don’t think such changes are politically feasible.

Let's assume this is true.  Mr. Ryan and Mr. Romney have specific two objectives, rolling back rates 20% and cutting deductions to offset.  My Orzag is making the assumption that the first objective will trump the second if they are in conflict.  He has no way of knowing this is true and, the projections in the Ryan budget actually appear to assume the first trumps the second sine the revenue line is revenue neutral to the current policy baseline.  Again, Mr. Orzag is offering no proof just the least charitable read he can offer.

Third, Ryan assumes that other spending, including nondefense discretionary spending, will fall from more than 12 percent of GDP last year to less than 5 percentby 2040. Again, he provides scant details on how to get there. 

This one is actually a bit funny.  Mr Orzag may want to read the President's budget at some point.  It assumes that total discretionary spending will fall to 5.0% of GDP by 2022.  The notion that Mr. Ryan might go from 5 percent to below 5% by 2040 doesn't really seem all that difficult to imagine.  You'd think as a past member of the Obama administration, Mr. Orzag might be aware of this fact.

Ryan says he would cut tax rates for all families, but that doesn’t mean the middle class would be any better off. Even after the Bush tax cuts, Ryan’s reductions would amount toabout $1,000 a year for families with annual incomes between $50,000 and $75,000— compared with a cut of more than $250,000 a year for those with incomes above $1 million.

This one is fun with numbers.  According to the TPC, the average family with an income of between $50,000 and $75,000 pays 5.7 percent of their income in federal income taxes (which is what is being changed here).  We'll charitably call that about $3500 per year.  This family is receiving a tax reduction of about one third, using Mr. Orzag's own estimate (which comes from the partisan CBPP).  The family with over $1,000,000 on average pays an average of about $600,000 in federal income taxes and receives about the same 1/3 reduction.  Thus, the gap in the amount saved is caused not by the unfair change in the tax code but by the gap in their current tax contributions.  As an aside, the tax rate changes in the Ryan plan do nothing to tax distribution.  It's simple math.

Furthermore, unlike the proposal from the nonpartisan Domenici-Rivlin deficit-reduction commission, the Ryan budget does not include any provisions to create jobs immediately. With unemployment above 8 percent, we should couple any long-term deficit reduction with additional support for the economy today. That would help the middle class more than promises of a tax cut that will probably turn out to be a mirage.

Oh dear.  So the Ryan plan is like the bipartisan Bowles Simpson plan in that it doesn't include immediate stimulus.  It is interesting that Mr. Orzag wouldn't mention the Bowles Simpson plan which his boss created.  With the deficit above $1 trillion already, perhaps Mr. Orzag should explain why the next trillion of deficits will do more than the first trillion. I'd also be curious if Mr Orzag would support all of Domenici Rivlin which, quite interestingly calls the same approach to Medicare as in the Wyden-Ryan plan (the current incarnation of Ryan's approach to Medicare).

“Both administrative costs (including profits) and payment rates to providers are higher for private plans than for Medicare,”the report said. That effect, according to the CBO, would outweigh any savings achieved by people choosing less costly health care.

But this assumption from the CBO is achieved by assuming that Medicare can continue to cost shift onto private insurance in perpetuity (which of course it cannot) and Mr Orzag also fails to mention that the plan would save the government a ton of money which the CBO concludes in the same report he cites.

Suffice it to say this piece which appears under the title "Five Myths About Paul Ryan's Budget" should probably be titled "5 Reasons Peter Orzag Has a Difference of Opinion with Paul Ryan."  To classify something as a myth typically requires demonstrating it is not true.  Mr. Orzag falls a long way short of that bar.

Horizontal Equity

Given the various incarnations of tax reform on the table, particularly from the Republicans in the Presidential debate, we are going to see a lot of discussion on the issue of tax equity.  Unfortunately, nearly all of this discussion is going to focus on the notion of vertical equity, that is, the equity between people of different incomes.

In some ways, a far more important discussion on the tax side is to be had around the notion of horizontal equity.  Oddly though, there is almost no published data on the topic of horizontal equity.  There are numerous papers on the topic as a conceptual matter but very little in the way of data.

But to illustrate the problem, we can look at the following table from the Tax Policy Center which shows the distribution of households who have zero or negative Federal income tax liability.  What this will show you is a reasonable number (thousands) of people with zero income tax liability who have high levels of income.  This fact is (in part) a result of lack of horizontal equity in the tax code.

There are literally hundreds of drivers of a lack of horizontal equity (mortgage interest deduction, child care credit, alimony income, etc.).  Each of these drivers is designed to fulfill some overriding policy objective that tax writers think they have; however, taken collectively they drive a large amount of horizontal inequity.

And horizontal inequity has effects that seep over into the discussion of vertical equity.  Remember the famous discussion about Warren Buffett versus his assistant.  Leaving aside the fact that Mr. Buffett did the tax calculation incorrectly, it is still a comparison driven by horizontal equity more than vertical equity.  People in Mr. Buffett's income class do in fact pay higher average effective federal taxes than people in his secretary's income class.  It is horizontal equity (and his faulty calculations) that drives this anecdote.

Which brings us to the debate over tax reform.  A smart campaign would push tax reform on the basis of horizontal equity.  Such a campaign would have a whole lot of ammunition to use.  The fact that neither side wants to talk about it is only an example of how much politicians like to be able to use the tax code to try to influence all of us to exhibit the "right" behaviors.

Why the Romney/Ryan Tax Plan is Bad Politics (and Unnecessary Policy)

A massive number of electrons have been killed on the Romney/Ryan tax plan prompted by several reports from the Tax Policy Center (TPC).  The reports basically make the point that revenue neutral tax reform, based on a 20% across the board rate reduction and retaining progressivity is impossible.  While there are some issues with the TPCs baseline (for example leaving the ACA taxes in the progressivity calculation), these issues are modest in context and don't really undermine the conclusion of the TPC analysis.

The tax plan put forward by Romney is bad politics for a number of reasons.

1. It bungles specificity.  If you are going to make a tax reform proposal, you either need to be very specific or very non-specific.  If you are going to be specific, you need to have done the distributional analysis and be ready to respond.  If you are going to be non-specific, go so high level (revenue neutral base broadening) that the plan is inherently a goal rather than the plan.  By doing neither, the Romney plan opened itself up to analysis like that done by the TPC and the campaign was not ready for the response because it hadn't done the work.
2. The plan itself is fundamentally irrelevant fiscally.  Since the plan, unlike Simpson-Bowles for example, was not designed to increase revenues; it doesn't actually change the fiscal picture.  Thus, in a campaign that should be about profligate current and planned future spending, this is a massive distraction that has exactly zero impact on the deficit.
3. The plan lacks foundation.  If you are going to make tax reform a central plank of your campaign, you need to establish the foundation of what impact you are expecting from tax reform.  Vague claims about unleashing growth or pro-growth reform are insufficient because revenue neutral tax reform is, by definition, going to have winners and losers and the losers are going to complain.

But beyond bad politics, the plan is also unnecessary.  Change, particularly major change, is inherently difficult.  Revenue neutral tax reform is not going to materially affect our fiscal trajectory nor improve the economy materially.  As such, putting a difficult policy that has a low return on the table is not a policy we need to embrace at this point.  The current tax code will get the job done.  Why change what you don't have to?

None of this should be interpreted as opposition to tax reform.  As readers know, I favor far more radical tax reform than what is proposed by Romney and Ryan.  It's simply a bad policy judgment at this point in time.

Ryan on the Ticket

Well, here's my obligatory post on the addition of Paul Ryan to the GOP ticket.

The good news, as others have commented, is that it seems likely that we will get a good policy debate on the role and future direction of the Federal government under way.  I think this is appropriate and good for the country.

The bad news is that reporters and pundits are really terrible at the way in which they report data.  Let me give you one example, here is Ezra Klein on the selection of Ryan.

7. Ryan upends Romney’s whole strategy. Until now, Romney’s play has been very simple:Don’t get specific. In picking Ryan, he has yoked himself to each and every one of Ryan’s specifics. And some of those specifics are quite…surprising. For instance: Ryan has told the Congressional Budget Office that his budget will bring all federal spending outside Medicare, Medicaid and Social Security to 3.75 percent of GDP by 2050. That means defense, infrastructure, education, food safety, basic research, and food stamps — to name just a few — will be less than four percent of GDP in 2050. To get a sense for how unrealistic that is, Congress has never permitted defense spending to fall below three percent of GDP, and Romney has pledged that he’ll never let defense spending fall beneath four percent of GDP. It will be interesting to hear him explain away the difference.

And while what Ezra says is true, it's terribly incomplete.  A few things to think about to put the oft bandied about 3.75% number in context.

First, the President's budget submission puts future discretionary spending at 5.0% of GDP by 2022 down from 8.7% of GDP in 2011.  Now, somehow, the difference from 5 to 3.75 doesn't seem quite as far as the difference between 8.7 and 3.75.

Second, let's do a little extrapolation exercise.  Suppose that real, per capita GDP growth averaged 1% between 2022 and 2050.  This is a good bit below the long term historical average but let's just assume it was.  And let's assume that discretionary spending grows at the rate of inflation plus population over that same period.  Care to guess what percent of GDP it would be in 2050?  How about 3.78%.

So, in effect, what Ryan is assuming is that spending will grow as 100 basis points slower than GDP growth on average in the long run.  A crazy assumption?  Horrible austerity?  Doesn't seem like either to me.

The question therefore is whether the actual facts will become known.  I'm not optimistic but the chances are higher today than they were yesterday.

An Annoying Inconsitency

You know how there are some things that get repeated often that just bug you.  Well, I wanted to briefly cover one of them here.  I'm hearing two arguments about fiscal policy that to me are entirely inconsistent.

One of them comes from the President...in short that we should raise taxes on some people in order to either pay for more programs or reduce the deficit.  In either case, the argument is some form of the fact that this won't be contractionary because the stuff we spend the money on or the deficit reduction will drive more growth than the reduction in growth from the tax increases.

At the same time, we're told that the states need more money so they can hire more teachers and spend more money on infrastructure.  Presumably, this money is going to come from the Federal government in the form of borrowing or maybe as a use for the increased taxes.

What bugs me about these two arguments is their inconsistency.  Either you are arguing that higher deficits are expansionary, in which case any tax increase is bad, regardless of what the money is used for or you are arguing that more spending is good, regardless of how you pay for it.  If it's the former, then a tax increase is bad no matter what.  If it's the latter then the state spending problem could and should be solved by state tax increases.

Just annoys me that people can make both arguments simultaneously without anyone looking at the relationship between them

Principled Spending - The Numbers

So now we come to the actual numbers that we would use for our principled spending budget.

Let's start with putting some numbers on the principles.  As you recall, our first principle has to do with base spending growth equally the growth rate of inflation plus population.  To get at this, I've used the last 5 year inflation rate for medical spending and other spending from the CPI.  For population, I've used the US population numbers with the exception of for Medicare and Social Security.  So to summarize, Medical spending has a projected inflation rate of 3.6% which is assumed constant for the next decade and the senior population grows between 2.7% and 3.5% per year depending on census projections.

The second set of numbers requires us to understand the current level of emergency spending and take it out of the budget over time.  For this, I have estimated reducing $100 billion in overseas contingency operations (Iraq and AfPak) and $200 billion in "income security."  Both of these are consistent with government estimates and the spending is reduced over a 4 year period from 2013 to 2016.

Finally, I apply an efficiency factor to government spending of 1% per annum.  In effect, this requires government to improve efficiency of delivery by 10 percent over the next decade but this factor is not applied to pure transfer programs (namely social security and other income security).

Finally, baseline defense (ex-OCOs) is treated as a special case.  Defense is assumed to grow only with the rate of inflation since population has little to do with the need for defense spending.

With these assumptions, we arrive at the following growth rates by category.

Defense (including OCO spending) - (0.4%)

Medicare - 5.7%

Social security - 5.2%

Non defense discretionary - 1.6%

Medicaid - 3.2%

Total spending - 2.2%

Or graphically, to compare the President's budget to the forecast, you get something that looks like the following:

And there you see the impact of excess spending over a principled baseline.  You may be wondering about the deficit against current baselines.  This number is pretty hard to calculate because of the large number of baselines.  However, using the revenue assumptions in the Ryan budget as a proxy for the current policy baseline, we would have a deficit in 2022 of 1.6% of GDP in 2022.  The deficit would fall below 3% of GDP in 2016.  All this from a simple change in spending orientation.

In the next post, I'll talk about how the tax code might change to fund this projected level of spending, since, as you recall, the principled approach to to tax enough to cover your spending.

Principled Taxation

Having dealt with the principles underlying spending, let's turn to the topic of taxation.  Again, in my opinion, three principles are sufficient to help us design our tax code.

1. The tax code should pay for the spending we do.  This is particularly true of what we call the "base" spending.  A tax code that does not cover the spending we do is of no use from a budgetary perspective.
2. The tax code should be as simple as possible.  There is no reason for the extremely large numbers of exceptions, rate, alternative rates and so forth in the tax code.  This type of behavior is simply a giveaway by legislators to preferred constituencies of all types.
3. Income below a certain threshold should not be subject to tax.  It is entirely true that some income should be shielded from taxation since that income is necessary for subsistence.

In following these three principles, what type of tax code would we get?  Basically, we would wind up with a tax code that exempts income below a certain threshold, say 1.5 times the poverty level and has a single rate above that threshold.  This rate would apply to all income and would replace all personal income taxes, including the current FICA tax.

Some might object to taxing capital income at the same rate as wage income.  To me, there is an interesting debate to be had on this topic but that debate should occur on the corporate income tax side of the ledger.  Making the personal code more complex because of an argument about the corporate tax code to me makes relatively little sense.  Furthermore, the notion that capital income requires preferential treatment seems to me out of keeping with the current environment for capital (e.g., a very fluid, global, capital system).

Others might object that this system is not "progressive" because there is only one tax rate.  Of course, the outcomes are progressive (meaning the effective tax rates are progressive) despite the fact that the rate table is not.  

Finally, some would object that this type of a system would eliminate refundable credits, basically payments made through the tax code.  My argument is that these payments, should they be necessary, should simply be made through expenditures rather than through the manipulation of the tax code.

What would the rate need to be to make this type of a tax code work?  More on that in the next post when we run the numbers.

Principled Spending

Well, it took me a lot longer than I had thought it would to come back to this but I did want to return to the principled view on taxes and spending.  As I said I would, let's start with spending and what the principles are that we might use and what they might mean.

So what are the principles we could use for spending?  I'd say there are really only 3.

1.  Government spending should grow no faster than the historical rate of inflation plus “relevant population growth.”  It is critically important to argue that government should be on a COLA the same way that our seniors are.  Why should government be able to expand its budget faster than anyone else simply because it perpetually borrows the difference?
2. Government may still institute “emergency” spending during recessions but this spending will be accounted for separately and brought to zero as the economy improves.  Explicit countercyclical spending should in fact be accounted for separately.  Failure to do this is what has allowed the budget to expand under President Obama.  The stimulus was baked into the baseline, a terrible mistake from the standpoint of fiscal responsibility.
3. This COLA approach (excluding any emergency spending) will form the new baseline for government spending from which we will attempt to drive even greater efficiency.  In other words, the COLA approach serves as a ceiling rather than a floor for spending (ex-emergencies).

Let's explore these a bit more in depth.  As to the first, we should ask our politicians to set some threshold that isn't a baseline for how fast government should grow.  As a cost center, government shouldn't need to grow faster than the population it serves plus the rate of inflation.  In fact, growth at inflation plus population more or less assumes no positive returns to scale.

Principle 2 is equally important for fiscal sustainability.  The government should differentiate emergency spending from baseline spending with the assumption that emergency spending will be reduced to zero once the emergency has ended.  Overseas Contingency Operations (the wars) are a good example of this but so are automatic stabilizers (like extended unemployment insurance).  Without an assumption that these emergencies go to zero, we never can differentiate whats "in the base" from what's "temporary."  Putting things in the temporary bucket ties them to external events.

Finally, the third principle is what we the people ultimately ask government to do on our behalf.  The more efficiency we demand from government (or the more economies of scale we believe exist), the more we should ask for a rate of growth below the "COLA baseline."

These principles may seem small but in point of fact their application would dramatically improve our fiscal position, a point I will cover after we cover tax principles in the next post.

Another False Choice

Here's a great new false choice that is being bandied about.  From Reuters reporting a Reuters/Ipsos poll:

The online poll found Americans split over the right course for government, with 51 percent of respondents saying they support dramatic cuts in government spending and 49 percent saying that increased infrastructure spending would improve the economy.

Let's take a quick look at why this is such a false choice.  Let's say you wanted to dramatically, say by 20 percent or so, increase infrastructure spending while simultaneously cutting government spending.  Would that actually be possible?

Well, helpfully, the government publishes statistics on infrastructure spending.  From the BEA National Income and Product Accounts, we can see that infrastructure spending in 2010 was $505 billion including state and local governments.  Meanwhile, total government outlays in the same period from the same source were $5.26 trillion.

So let's see, a 20% increase in infrastructure spending would be $100 billion or a 2% decrease in government spending somewhere else.

Let's face it, the issue with infrastructure spending has nothing to do with how much money the government has to spend, it's all about what the government chooses to spend the money on.

If you're complaining about your roof leaking while taking a $100,000 vacation, there aren't a whole lot of people who are going to have sympathy for your plight.

A Principled Approach to the Budget - Rationale

Over the next several posts (hopefully over the next week or so), I'm going to take on the budget from scratch with a very different orientation than in the norm.  My posts are, except for comparative purposes, going to ignore all of the various baselines and all of the plans that have been advanced.  The reason for this is simple.  I've concluded that there is no possible solution to our budgetary issues until such time as we move to a principled discussion about taxes and spending.  So today's post will be a bit of description of where I'm going, the second post will cover spending, the third will cover taxes, and the fourth will put numbers to the principles, starting with today's budget and make the case for a radical but maybe possible solution.

What would a principled discussion look like?

It would start with stating the rules that one thinks should govern the budget.  Not the actual expenses by category but the rules that would determine those expenses.  It would also not make reference to any spending beyond today's spending.  Today's spending is certain.  Forecast spending is anything but.  Forecast taxes are similar.  It would then do a similar thing on taxes and lead to a solution where the actual rules are an outcome of the application of the principles.  A discussion that starts with the outcome simply put masks any principles that might be behind the outcome, as the various parties angle to explain why their solution is the only solution without ever explaining why the solution works.

Why is a principled discussion necessary?


I've referenced this a bit above but a principled discussion is necessary because it's the only way out of the current nondiscussion we are having about the budget and about taxes.  One cannot possible enter into the discussion without a lot of knowledge and research.  By contrast, a principled discussion is something that anyone can engage in.

Second, a principled discussion takes us out of the debate about winners and losers, at least for the moment.  We can discuss the principles without knowing how they will affect results.  Indeed, as of this moment, I'm not sure what numbers are going to result from what I am proposing.  I have some gut instincts since I know what the principles are but I actually haven't done the math yet.

Finally, a principled discussion more clearly helps us see the areas of disagreement than a discussion around the numbers.  It is probably possible to start from the current budget and tax structure to infer principles but, particularly on taxes, it would be difficult to clearly define them.  When we disagree on the principles, we open ourselves up to a discussion of why we disagree.  When we argue the numbers, there tend not to be good "why's"

So where do we go from here?


Let me be clear.  My intent in doing this really is to propose a budget and a tax structure.  The end game is to get us there but also to be totally transparent on how I got there.  I'll also point out that when I get to the numbers, it will be done at a fairly high level since I don't have the time to do it at a more detailed level.  That said, a more detailed approach would be both feasible and beneficial.  As a minimum, I'll find out a lot more about what I think.  At a maximum, maybe it will create a blueprint for a new way for us to both talk about and to set the budget and the tax code.

Now the New York Times is Doing it too

Further to my recent post on the Buffett rule, here's the New York Times on the Buffett rule.

Unfairness in the tax burden is one important example and driver of that divide. The White House released tax data showing that the average federal tax rate of the wealthiest 0.1 percent of Americans has fallen from 51 percent to 26 percent over the last 50 years. At the same time, the middle-class tax burden was basically unchanged or slightly higher, with those taxpayers paying 16 percent of their income in federal taxes in 2010, versus 14 percent 50 years ago.

But of course, the "tax data" that the White House released isn't tax data at all.  It's invented data invented by the Council of Economic Advisors to make the political point that the President wants to make.  They are not referencing historical data but a modeled exercise, a modeled exercise that does not comport to the actual historical data.

No doubt there's a reasonable argument for the data released as being a good way to assess changes in taxes but to argue (as the WH does) or infer (as the Times does) that this is somehow historical data is simply false.

Making Stuff Up About the Buffett Rule?

On the White House website, as of 7PM Eastern on April 10, you can find the following graph






Now if you read to the bottom, you'll see the source as "CBO."  I found this pretty interesting because, to my knowledge, the CBO has never published effective tax rates back to 1960.  I know because I've spent a lot of time looking for them.

They have published effective tax rates back to 1979 and you can find those here.  Let's do a quick comparison.  The WH chart shows the effective tax rates of the top 0.1% as below those of the top 1% from 2003 on and says the source is the CBO.  Meanwhile the CBO data (which only goes through 2005) shows no such thing.  The WH chart also appears to show (based on interpreting the axes) far higher tax rates than were actually in place according to the CBO report in 1980.  But since they haven't published the data or linked to the CBO, it's a bit hard to know.

But it's this chart that allows the WH to argue that tax rates have declined by more than 50 percent for "the wealthy."  Meanwhile the CBO data for the top 0.01% shows a decline of about 30 percent from 1979 to 2005, pretty much the same decline in percentage terms as most income groups although less than those in the bottom quintile.

So I'm left with 2 questions:  Did the WH misquote the CBO?  If they did, where did the data come from?  If they didn't, can they show us the CBO data?

Update:  The White House shows in a different report the same data but in this report, they clearly source the data as not coming from the CBO and not even being actual data but rather data created by the CEA.  The specific quote is: "Average Federal tax rates for a sample of 2005 taxpayers after adjusting for growth in the national wage index" and the source is basically CEA analysis.  CEA/CBO what's the difference?