Nothing is Wrong with a “Do-Nothing” Congress!

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Nov 18, 2011

The Budget Control Act of 2011 established a joint congressional committee (the “Super Committee”) and charged it with the responsibility of reducing the deficit by $1.2 trillion over 10 years.  If the Super Committee fails to reach an agreement, automatic cuts of $1.2 trillion over 10 years are triggered, starting in January 2013.  These are said to be “across the board”, but they are not.   They would apply $600 billion to Defense, and $600 to other spending.  Entitlements are exempt, including the Supplemental Nutrition Assistance Program (SNAP, formerly food stamps) and refundable tax credits such as the Earned Income Tax Credit and child tax credit.  These entitlements are exempt from the cuts because anyone who qualifies can participate (that spending is determined by participation, not by Congress).

In addition, the Bush-era tax cuts are set to expire at the end of 2012, so doing nothing means that tax rates would jump back to pre-2001 levels.  That combination might be the best thing yet for our huge budget deficit.

The Federal government’s annual deficit has been more than $1 trillion since 2009.  Continuation of that excess spending might create a debt crisis similar than the one now in Europe.

The Center on Budget and Policy Priorities estimates that the trigger would cut $54.7 billion annually in both defense and non-defense spending from 2013 through 2021.  Meanwhile, U.S. defense spending is around $700 billion per year, with cuts of about $35 billion per year already enacted, so the automatic trigger would reduce defense spending from about $665 billion to about $610 billion.  Some may view that 10% cut as draconian, but the simple fact is that the U.S. needs to wind down its spending on two wars.  Congress and voters are fooling themselves if they think the U.S. can continue to spend the same level on defense, not raise taxes, and make any major dent in the huge annual deficit.

The same point can be made for automatic cuts in Social Security, which in its current form is unsustainable.  Since it was enacted in 1935, life expectancy has increased dramatically, which means more payouts than anticipated.  Birth rates have declined, which means fewer workers and less payroll tax than anticipated.  The system will run out of money in 2037.  Congress either needs to raise taxes or cut spending.  But they won’t do either!  The only solution might be the automatic course, without action by Congress!

For further reading, see “Why doing nothing yields $7.1 trillion in deficit cuts”.

To Reduce Energy Use, Buy an 8-cylinder 1980 Bonneville!

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Nov 4, 2011

My green choice is to get about 12 miles to the gallon.  Here is why it’s so green.

Some people think it’s obvious that I ought to buy a hybrid or other fuel-efficient vehicle.  But that’s just wrong.  Certainly some drivers should have a hybrid car to reduce emissions and energy use, namely somebody like my brother who has an hour commute each day, driving 20,000 or more miles per year.   But not everybody.   Take for example a person like me who lives near work, rides a bicycle, and doesn’t like spending hours in the car – even for a road trip to the Grand Canyon or Yosemite.  I use the car once a week for the grocery store, or a restaurant, driving less than 5,000 miles per year.

Let’s suppose a hybrid gets 50 miles per gallon, so my 5,000 miles per year would cost about 100 gallons ($300 per year).   The standard non-hybrid gets 25 miles per gallon, which would cost twice as much ($600 per year).  I’d save $300 per year in the hybrid.  But that doesn’t mean I should buy a hybrid.  A new hybrid like a Toyota Prius costs about $6,000 extra to get that great fuel-efficiency (about $26,000 instead of $20,000).    In other words, it would take twenty years for my $300-per-year savings to make up for the extra $6,000.  It’s not worthwhile for me.  If my brother drives four times as much, however, he could break even in just five years.

So far, that means I should not buy a hybrid.  Does that mean I buy the normal new car with 25 mpg for $20,000?  No!  I should buy a beaten old 8-cylinder Bonneville, which looks like a tank and gets only half the mileage!  That Bonneville may be headed for the junk heap, so it’s certainly cheaper, even if I have to pay more for gas.

But even ignoring the price of the Bonneville, I claim that the fuel-use of the Bonneville is less than the fuel use of the normal new car!  Why?  Consider the emissions from fuel used in production.  The fuel used to make the Bonneville back in 1980 is a “sunk cost”, a done deal that does not change whether that car gets junked now or later.  In other words, keeping that Bonneville off the junk heap requires no extra fuel and emissions to produce it.  But buying a new car does involve more fuel and emissions just to produce it.  Think about all the emissions from the steel mill, the tire factory, the glass furnace, and the electric generating plant that provides power for the tools and machinery to make the new car.

In other words, I can reduce total fuel use and emissions much more if I purchase the 1980 Bonneville and drive it 5,000 miles per year, than if I buy a new car with twice the mpg.  Now all I need is a bumper sticker for my 1980 Bonneville to say how green I really am!

 

A Look at Herman Cain’s 999 Tax Plan

Filed Under (Finance, Other Topics, U.S. Fiscal Policy) by Don Fullerton on Oct 21, 2011

The point of this blog is to inject some substance into discussion of Presidential candidates. To see the problem, consider what I wrote on my facebook page: “In an airport for an hour yesterday, we could not avoid hearing CNN talk about the upcoming presidential debate. For the entire hour, we heard only comments like: Perry needs to come out swinging; or, ‘Is Cain a viable candidate?’; or, Bachmann has really fallen in the polls; or, ‘This now boils down to a two-man race’, followed immediately by the wisdom that ‘Yes, but we don’t know yet who the two men are.’  What inanity! It is JUST a horse race! Not a single comment during the entire hour had anything whatever to do with any substantial issue of policy. Is this all we get?”

There must be more to consider, in this important decision.  So, I started by looking at Herman Cain’s 999 tax reform plan.  See more at his website, with the key bullets in the insert below. 

Bear in mind that I’m a former Deputy Assistant Secretary of the U.S. Treasury (1985-87), so I worked hard on President Reagan’s successful “Tax Reform Act of 1986” to lower the rates and broaden the base.  Since 1986, however, Congress has managed to reintroduce plenty of new deductions and tax breaks, while raising the rate.  Maybe it’s time to do something again!

Cain’s proposal has a lot of similarities to the 1986 reform, if perhaps more extreme.  It is meant to be revenue neutral, raising the same total tax.  It would eliminate virtually ALL deductions, like mortgage interest paid, and it would cut rates drastically.  It would eliminate the income tax as we know it, and introduce a national sales tax (or value added tax).   What about the accuracy of Cain’s claims below?  By reducing rates drastically, this proposal probably WOULD reduce the distorting effects of taxation by reducing the interference of taxes in the productive activities of workers and business – what economists call “deadweight loss”.  For similar reasons, it probably would provide greater incentive for work and investment, and therefore probably provide some stimulus to growth.  That’s all for the good.

However, ANY tax reform plan of ANY politician EVER, no matter what motivation, will always have two effects to watch out for.  First, any tax reform will always raise taxes on some taxpayers and reduce taxes for others.  It will have distributional effects worth analyzing.  Second, it will therefore create disruptions and reallocations.  Activities to pay additional tax may shrink – laying off workers who may remain unemployed for some time until they can re-train and find work in other activities that now face lower tax rates and hope to expand.  That is, for only one example, the Cain plan might hurt homeowners and homeownership by eliminating the mortgage interest deduction.  With such pervasive changes, however, the disruptions will be widespread and costly in themselves.

Finally, for now, note the point about distributional effects.  Nothing in any of Cain’s bullets says anything whatever about distributional effects.   I’m afraid this point is the Achilles heel of Cain’s 999 plan.  According to the non-partisan Tax Policy Center, Cain’s plan will greatly reduce taxes of those with the highest incomes and raise total taxes on those with low incomes.  It is ‘regressive’.  And you don’t even need to read the TPC analysis to know this is true.  Cain’s plan cuts the top personal rate from 35% to 9%.  There is no amount of tax-base broadening for those high income taxpayers that can get back the same tax revenue from them.  And currently those with the least income pay no Federal tax at all.   Under Cain’s plan, everybody will pay the 9% sales tax, on everything they buy.  Moreover, if those low-income individuals are working, they will probably bear some additional burden of the 9% business tax that applies to all profits AND wages paid: it applies to all sales revenue minus purchases and capital investment, not subtracting wages paid to workers.

I’d personally favor another revenue-neutral reform like the TRA of 1986, one that lowers the rates and broadens the base.  Such a reform would undoubtedly cause some disruptions and adjustments costs.  And it would help some while hurting others.  But perhaps it could be designed in a way that also tries to be distributionally neutral, not adding tax burdens on those least fortunate while cutting taxes on those already doing well.

What is the meaning of a budget number?

Filed Under (Environmental Policy, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Oct 7, 2011

With all the argument in Washington about how to balance the budget, a reminder is worthwhile that none of these numbers make any sense at all!  What “should” be the meaning of the government budget?  And, does any number provided by anybody actually have that meaning?

In general, a budget deficit is supposed to mean that one’s current consumption exceeds income, which would indicate a decrease in wealth.  Indeed, that’s the problem with a deficit – drawing down our wealth (which could even turn from positive to negative!).  The U.S. Federal budget numbers fail to provide such a meaning, for several reasons.

First, the Federal budget includes ALL spending, not just consumption.  Some of that spending is actually investment, such as new spending on buildings, bridges, roads, airplanes, and any long-lived military equipment.  The budget does not show the breakdown between what we really use up this year, and what spending is really investing in the future.

Second, Social Security is “off-budget”, unless you are looking at a unified budget.  Okay, I said that in a way that is intentionally confusing!  The basic problem here is that social security is SUPPOSED to run a surplus, so that we can set aside some funds from those now working to pay them when they are retired.  If it does not run a surplus to save for the retirement of the baby boom generation, then we’ll be in big trouble when the baby boom generation retires!  The current social security surplus is too small for that.  Then, however, the big problem is that the unified budget mixes the social security budget with the rest of federal spending.  So when you see a deficit in that account, it’s really worse than it looks, because it includes the small social security SURPLUS that’s already not a big enough surplus for social security to break even!

Third, the U.S. Federal Budget is confusing about what is a “Tax Expenditure” and what is government “Spending”.  A tax expenditure is really ‘spending via tax break’, as when a taxpayer gets a special credit or deduction for doing some particular activity.  The Congress could instead have accomplished the exact same thing by an ACTUAL spending program, providing subsidy to the same set of eligible individuals for doing the exact same activity.  So it really does not make much sense to say you want to cut spending and not raise taxes, because eliminating one of those tax breaks is really the same as eliminating an equivalent spending program.

Fourth, a Federal “mandate” might require a certain kind of spending by a firm.  To take a simple example, suppose some safety regulation requires construction firms to provide a hard hat to all workers.  That’s really equivalent to a tax on that firm, equal to the amount they have to spend on hard hats, where the revenue of that “tax” is spend by government on the provision of hard hats.  But then the problem is that mandates are so pervasive.  Some ‘true’ measure of the size of government would be HUGE, if we counted the dollar cost of all mandates as a “tax”, as if it were in the government budget.

A Global Problem with No Solution

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Sep 25, 2011

If one town’s water pollution flows into another town, the two towns can negotiate a solution with no need for the state to intervene.  But if all towns are polluting all neighboring towns, the lines of communication are too complex to negotiate – requiring the state to pass a law to solve the problem.

If one state’s water pollution flows into another state, the two states can negotiate a solution with no need for Federal intervention.  But if all states are polluting all neighboring states, the lines of communication are too complex to negotiate – and it takes a national government to solve the problem.

In other words, those problems have solutions.  If one nation’s water pollution flows into another nation, then (potentially, at least) the two nations can negotiate a solution with no need for a global government to intervene.  But if all nations are polluting all neighboring nations, the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

I’m currently pessimistic about two of the worst problems the world has faced: global climate change, and global financial contagion.  Both are “externalities” in the classic sense.  Each nation’s greenhouse gas emissions pollute the whole world, and the only really effective solution is a worldwide global agreement to reduce emissions.  In fact, we don’t really “need” all nations to reduce emissions; all we really need is an agreement among all nations saying that if SOME countries reduce emissions then the other countries won’t increase emissions to steal their business.  But the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

Environmental policy is my usual bailiwick.  At the moment, however, I’m even more worried about global financial contagion.  It seems that one small country can have lax financial regulations that allow banks or investment companies to take on too much risk.  Or a small country can overspend, taking on too much debt.  In the olden days, that country could go down in flames, with no big problem for the rest of the world.  With tremendously increased globalization, however, all financial markets are highly integrated.  One country’s borrowing may come from any or all other countries of the world, and one nation’s problem become the world’s problem.  If banks in other countries loan to that small country, then a financial crisis in that small country may create fear about the financial well-being of the banks that lent to them, causing a run on the banks in all those other countries.  Moreover, globalization means much more trade in commodities.  If one small country faces severe financial difficulties and must cut back all spending, that reduces aggregate demand worldwide, and can spread a recession worldwide.

A strong global government could rein in the poorly managed countries by requiring larger capital requirements, careful financial scrutiny, and only tax-financed spending.  But we don’t have any such global government.  As a result, even a small country like Greece can over-spend for years without oversight.  The situation in Greece may be made worse when banks in other countries raise the rate at which Greece can turn over its debt and borrow again, making the financial situation in Greece even worse.

The problem may be caused by Greece or not.  Regardless of “fault”, if Greece any small country were to go into default in years past, then the cost would be primarily on that small country.  Now Greece could go bankrupt and impose horrible costs on the entire World?!?

Closing the Barn Door after the Horses Escape

Filed Under (Finance, Other Topics, U.S. Fiscal Policy) by Don Fullerton on Sep 2, 2011

The New York Times today says that the Federal Housing Finance Agency is set to sue major U.S. banks such as Bank of America, JPMorgan Chase, Goldman Sachs, and Deutsche Bank, among others.  The U.S. government argues that the banks sold packaged mortgages as securities to investors while ignoring evidence that the homeowners’ incomes were inflated or falsified.  That is, the banks failed to perform the due diligence required under securities law.  When many of those homeowners were unable to pay their mortgages, the securities backed by the mortgages tanked.  Housing and financial crises ensued.

Kinda late, isn’t it?  Well, certainly it’s too late this time, to prevent the housing and financial crises of the past few years.  What is the point of the suit, then?  Does the U.S. Federal government really need the money that they can get from these banks, as damages, and will they give it back to all of us who lost money during those years?  The U.S. might sue for around a billion dollars, which is peanuts these days.  Divided by 333 million Americans, that would be about three dollars each.  Why bother?

An important conceptual point here is the difference between ex post liability (after the fact) and ex ante incentives (beforehand).   The point of this suit is not to collect a billion dollars after the fact, although arguments are made about the fairness of those liable to pay for damages.  Rather, the point is to provide the proper incentives to private companies before the next time.  To a private company, a billion dollars really is a lot of money.  If they have to worry about the loss of a billion dollars, for ignoring their legal responsibilities, then maybe next time they’ll be more careful to follow the law.

Government regulation can take alternative forms.  One alternative is to send auditors and inspectors into every bank, every day, to check what they are doing.  That would be very expensive.  A cheaper alternative is to let the banks decide for themselves if they are exercising due diligence, but with the “threat” hanging over their head that they might get sued if they don’t.

Are U.S. Taxes Too High?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Aug 19, 2011

The last-minute deal between Congress and the President managed to save the day, just before the deadline, but it’s not a very specific plan.   Any coherent long term plan for serious deficit reduction will still have to include cuts to defense and cuts to entitlement programs like Social Security and Medicare.  But the Republicans did not want to cut defense, the Democrats did not want to cut Medicare, and they can’t cut the large portion of the Federal budget that goes to interest payments on existing debt.  So instead, in the short run, they load high percentage cuts onto the small percentage of the remaining Federal budget that could be called discretionary.  Thus it seems we will experience very large cuts to items like National Parks, environmental programs, highways, training, education, and social infrastructure.

If the American people really want a government that is extremely small, especially compared to other developed economies such as those in the OECD, then the deficit problem could conceivably be solved by spending cuts alone (as long as those cuts include defense and entitlements).  Certainly some Tea Party Republicans want a Federal budget that small.  But I suspect that some other Republicans only think they want a Federal budget that small and would change their minds once they see the decimation of so many Federal programs.

In 2009, before the current round of cuts, the United States ranked third-to-last among the 23 OECD countries for the percentage of GDP collected by government.  I’m sure we would not want to match the 48% collected by some Scandinavian countries, or even the 40% collected by other European countries.  Somewhere in the middle, Canada appears with 31% of GDP collected by government.  The United States stood at only 24%, which exceeds only Mexico and Chile.  With only spending cuts and no increase in taxes, the U.S. could soon have the smallest government among all 23 nations of the OECD.  The following graph is from the Toronto Globe and Mail.

 

What might this mean for our state? Illinois is quite unusual, having just raised the State income tax to cover some of the growing annual deficit.  Other states with new Republican governors have drastically cut spending instead of raising taxes.  These actions might nudge Illinois upward, in the ranking of states by the ratio of tax collections to total state income, but it may allow Illinois to meet more of its obligations (including unfunded pension liabilities).  If Illinois did not raise any taxes, it may have had to renege on some such promises.

Republicans would tell you that smaller government and a smaller tax bite is always better for job growth.  But it’s a matter of degree, and a matter of balance.  A state with the smallest possible budget would have very little spending on infrastructure, road quality, sanitation, police protection, education, training, and other social services.  Yet many of those programs are important for businesses to be able to function properly.  The trick is to find the right balance, with spending on the minimal decent level of such programs, as necessary for businesses and employees alike.

With no increase in Federal taxes, the recent deal on cuts in spending is likely to mean cuts in all kinds of Federal discretionary spending, including grants to the states.  The U.S. Congress will then be likely to enact more unfunded state mandates, which means requiring the states to spend their own money to provide basic services that the Federal government used to provide.  State governors and legislators will be unhappy about these changes, with even more pressure on state governments.

Green Taxes Part III: Potential Revenue for Illinois?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jul 15, 2011

In my last two blogs, I wrote about ways to meet the Illinois state revenue needs, ways that might work better than the increase in the income tax.  This blog continues the list of possible “green taxes”.  In general, a green tax applies either directly on pollution emissions or on goods whose use causes pollution.  For raising a given amount of revenue, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate what caused the fiscal crisis in Illinois, nor argue the merits of cutting spending versus raising revenue.  Instead, we just take it as given that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of a few green taxes as alternative ways to raise revenue.

While many green taxes are possible, we focus on four examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  In past weeks we covered Carbon Pricing and Gasoline Taxes.  This week we cover Trucking Toll and Garbage Fees.

Every day hundreds of thousands of vehicles crowd Illinois’s roads and highways.   Data from the Federal Highway Administration indicates that over 50,000 trucks (six tires and over) cross into Illinois from neighboring states along the interstate highway system.  While these trucks bring needed goods to Illinois, they also congest the roads, degrade the road surfaces, and fill the air with soot.  They also become involved in vehicle accidents that cost the lives of many in Illinois.  To compensate the state, Illinois can impose a toll for long-haul trucks using Illinois’s highways.  For example, a $5 per truck toll on 50,000 trucks daily would raise almost $100 million annually.  (In comparison, the existing Illinois toll road system generates approximately $600 million annually.)  The truck toll can be implemented using existing transponder technology deployed at weigh stations along the interstate highways.  (As an aside, we note, the constitutionality of state trucking tolls is not clear, because the federal government determines the rules of interstate commerce; however, major portions of the existing interstate highway system are subject to tolls, including the heavily travelled I-95 corridor in Delaware. )

Next, residents of Illinois generate approximately 19 million tons of garbage per year (or more than one ton per person per year), and 60 percent of that waste ends up in landfills.  Currently, large municipal waste landfill operators currently pay state fees that total $2.22 per ton of solid waste dumped.  But few municipalities in Illinois charge fees designed to discourage the creation of waste by residents (Don Fullerton and Sarah M. Miller, 2010, “Waste and Recycling in Illinois,” Illinois Report 2010, pp.70-80). 

However, empirical evidence shows that taxing garbage at the residential level does reduce garbage production (Don Fullerton and Thomas C. Kinnaman, 1996, “Household Responses to Pricing Garbage by the Bag,” American Economic Review, 86, pp. 971-84).  Yet the exact garbage taxation mechanism varies by program.  For instance, a fee can be levied on garbage bags themselves or on the containers that hold the garbage bags.  Regardless, a tax rate equivalent to one penny per pound of garbage would generate almost $240 million in revenue per year, or 6.3% of the expected revenue from the income tax increase.

Finally, consider a Portfolio Approach.  Remember, at issue here is not whether to raise taxes.  We presume the State has decided to raise taxes by $3.8 billion (as done already through the income tax increase).  Here, we merely explore alternative ways to raise revenue other than through the income tax. 

Anyway, instead of implementing only one of the green taxes describe above, Illinois could choose to implement several green taxes simultaneously.   This portfolio approach would keep rates low for each individual green tax, but still generate large amounts of total revenue that can add up to a large share of the total expected revenue from the recent income tax hike.  According to the numbers in all three blogs, one simple and moderate plan would combine the following green taxes and pay for more than  half of the needed revenue:  A carbon tax of $10/ton would collect $1 billion (raising electricity prices by about 7.5%), a gas tax increase of 14 cents per gallon would collect $0.7 billion (raising gas prices by about 4.4%), a trucking toll of $5 would collect $100 million, and a garbage fee of one penny per pound would collect $240 million.  Then the recent income tax increase could be cut by more than half.

Moreover, green taxes have the added benefit that they provide incentives to reduce the polluting effects of carbon emissions, gasoline use, truck exhaust, and household garbage generation.

Green Taxes Part II: Potential Revenue for Illinois?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jul 7, 2011

Last week, I wrote about carbon pricing as a way to meet the Illinois state revenue needs (instead of an increase in the income tax).  This week, in the “continuation”, I write about a possible increase in the gasoline tax.  First, I’ll set the stage again.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate the reasons for the underlying fiscal crisis in the State of Illinois, nor argue the merits of cutting spending versus raising revenue to balance the budget.  Instead, we just stipulate that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of “green taxes” as an alternate means of raising revenue that could mitigate or eliminate the need for increasing income taxes.

In general, green taxes are taxes either directly on pollution emissions or on goods whose use causes pollution.  In the revenue-raising context however, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

While many green taxes could be implemented, we focus on four specific examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  This week: Gasoline Taxes.

Gasoline sales in Illinois are subject to a state excise tax set in 1990 at $0.19 per gallon.  In addition, other state fees and a federal excise tax of $0.18 per gallon are applied to gasoline sales for a total tax rate in Illinois of $0.61 per gallon, according to the American Petroleum Institute.  However, economic studies find that the existing tax rates on gasoline are below the optimal rate that would account for all the costs of pollution and time wasted due to traffic jams.  For instance, the “optimal” U.S. total gasoline tax has been estimated to be about $1 per gallon, according to Ian Parry and Kenneth Small (2005), “Does Britain of the United States Have the Right Gasoline Tax” [American Economic Review, 95(4): 1276-89].  Illinois would have to raise the tax rate by 40 cents to reach that $1 total optimal rate.  The third line of table 2 shows that a $0.40 per gallon gasoline tax hike would collect approximately $2.0 billion (just over half of the $3.8 billion from the income tax increase).  Yet that tax increase would raise by 12.4 percent the $15.9 billion Illinoisans spend annually on gasoline.

Table 2 includes alternative calculations of revenue generation levels from a gasoline tax.  For example, a generic 5 cent per gallon excise tax increase would generate $250 million (see table 2 line 1). 

The existing $0.19 per gallon excise tax in Illinois is not indexed to inflation, so the real revenue to the State from the gasoline excise tax has steady fallen over time.  The second line of table 2 calculates that the state could adjust the tax rate back to its 1990 purchasing power by raising the rate 14 cents per gallon (from 19 cents to 33 cents).  That would just account for inflation since 1990.  The increase in revenue would be $700 million (which is 18.3% of the expected revenue from the income tax increase).

Illinois residents would then pay 4.4% more for gasoline, INSTEAD of paying more income tax.  The point is that the gas tax would discourage driving and air pollution, instead of discouraging workers from earning income.

 

 

Behind all the deficit talk are very different versions of American government

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Jun 9, 2011

If you listen to our politicians these days, you hear a lot about the deficit, the debt, the debt ceiling and so on.  In other words, much of the talk focuses on the need to bring spending and revenue into balance, and rightly so.  And, sooner or later we’re going to do that.  We’ll address social security, either through raising taxes or reducing benefits or both, and we’ll do something about health care costs, although I’m not sure anyone has a good idea for exactly how.  Maybe we’ll get lucky and grow our way out of this mess while we still have our heads firmly stuck in the sand.

What I want to focus on today is what American government is going to look like when all is said and done, and the very different visions coming out of the Democratic and Republican camps.  Although others have talked about this, I think it is a point worth making again.  So, here goes.

Consider the following graph, which appeared earlier this year in a Wall Street Journal article by John Taylor.  Now, the Taylor article is not exactly flattering to President Obama, and I don’t mean to endorse his main argument here, just to adapt his graph for my own purposes. 

What we see here are graphs of government spending as a percentage of GDP under President Obama’s budget through 2021 as well as the House Budget based on Paul Ryan’s Roadmap budget that was passed in April.  Note where they end up.  The Obama budget heads toward a government that runs around 23 percent of GDP, our best measure of overall economic activity in the country.  The House/Ryan plan ends up closer to 20 percent.

In the longer run, these differences become more pronounced.  The CBO’s long-run projection for the Ryan plan have government spending decreasing to 17 percent of GDP in 2022 and continuing down to 14 percent of GDP by 2050.  (These numbers don’t count interest paid on the national debt.)  Projecting out the Obama budget, as far as I can tell, hasn’t been done.  However, the same CBO report has long-run budget projections under current law (as of June 2010, so the impact of PPACA (health reform) isn’t in there yet) have spending as a fraction of GDP at 22½ percent in 2022 and increasing to 28% by 2050.  Now, the recent Obama budget makes some effort to rein in spending over the medium term, so maybe it puts us on a trajectory toward a government that is, say, 24% of GDP.

All of this assumes that the plans can do something about the rate of growth in health care costs, so take it with a pound of salt.  Oh, and keep in mind that this is federal spending and does not include spending on state and local government. 

So, there you have it.  Sooner or later we’re going to have to start paying for what we’re spending.  The question is, do we want to have a government that spends less and provides fewer services, as in the Republican plan, or a government that spends more and provides more services, as in the Democratic plan.  Now, a government that spends 14 percent of GDP (not including interest) is smaller than anything we’ve had in the last 40 years.  But, it doesn’t seem crazy.  A government that spends 24% of GDP is at the top end of what we’ve seen, but again, not a radical outlier.  And yet, a 10 percentage point difference in what our government spends is something like $1.5 trillion.  So, these will be two very different worlds.

If whether you are a Republican or a Democrat or neither, the battles that are being fought over debt ceilings and entitlement reform are skirmishes in a war over the future direction of American government, and these are very different directions.