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