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”.

Dallas Fed President: Buy a ticket!

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Nov 3, 2011

Dallas Fed President Richard W. Fisher gave a highly interesting, thought-provoking speech last week.  His full remarks are posted here.  Among the interesting points he raised are:

  • “[I was told] the story of a God-fearing man who prayed several times a day, imploring the Lord to let him win the lottery. Day after day, year after year, God listened to this man. Finally, He grew weary of the man’s prayers and spoke to him: “Help me out, my son, so that I might help you,” the Lord said. “Buy a ticket!”…  I am going to suggest that our nation has a crying need for public leadership to correct what is wrong with our economy; that the Federal Reserve has provided the leadership required of it; that monetary policy cannot do it alone and must be complemented by responsible fiscal policy—policy that is exclusively the responsibility of those whom we elect to represent us in Washington; that rather than posturing for political expediency and positioning for victory at the polls in November 2012, our nation’s political leaders need to actually “buy a ticket” and put themselves at risk, right now and without delay. Each passing day they fail to do so further jeopardizes our economic stability and our nation’s future.”
  • “The parties involved must stop the hemorrhaging without inducing cardiac arrest; they must solve the long-run debt and deficit problem without, in the short run, pushing the economy back into recession, creating still more unemployment. And they not only must confront their addiction to debt and spending beyond their means, but also reorganize the tax system, redirect the money they spend and rewrite the regulations they create so as to be competitive in a world that wants to beat us at our own game.”
  • “Only fiscal authorities have the power to affect this outcome. Monetary authorities, like me and my colleagues on the Federal Open Market Committee (FOMC) of the Federal Reserve, have limited influence. We can fill the gas tank with attractively priced fuel―abundant and cheap money―needed to propel the economy. But we cannot trigger the impulse to step on the pedal and engage the transmission mechanism of job-creating investment by the private sector. This is the province of those who write our laws and regulations―the Congress of the United States.”
  • “I would suggest to you that the time is now. Our nation’s economy is at risk. The Federal Reserve is doing everything it can to bolster unemployment without forsaking our sacred commitment to maintaining price stability. I personally don’t care which party is in the White House or controls Congress. All I know is that the “honorable” members of Congress, Republicans and Democrats alike, have conspired over time, however unwittingly, to drive fiscal policy into the ditch. They purchased their elections and reelections with popular programs so poorly funded that they now threaten the economic well-being of our children and our children’s children. Instead of passing the torch on to the successor generation of Americans, the Congress is simply passing them the bill. This is the opposite of honorable, and it must stop.”

HT: Leeds on Finance via Jerry Carson.

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?!?

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.

Trickle-Down Debtonomics: How a Failure to Raise the Debt Ceiling will Impact State Budgets

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Jul 31, 2011

As I write this blog, President Obama and Congressional leaders have still failed to agree on a deficit reduction package that would provide sufficient political cover to allow a majority of Representatives and Senators to vote to raise the debt ceiling.  (If they manage to pull a rabbit out of a hat this weekend before this post goes public, you can view this as a “what could have been” post.)

 Last week, I pondered the impact of a failure to raise the debt ceiling on broader economic activity.  A few days later, my colleague George Pennacchi, in an interview, provided further detail about the economic impact (read it here).  If politicians decide that they do not want to skip interest payments, and if they do not want to shortchange senior citizens or the military, then we are going to have to pretty much make everyone else wait for their payments.  One group that has been largely overlooked in the discussion – state and local governments.

 An exception to the overlook is a report issued by Pew Center for the States.  They point out the direct and indirect ways that the failure to raise the debt ceiling could negatively and substantially impact state and local budgets.  A few examples they cite include delayed payments to states for the many programs for which there is shared budgetary responsibility, such as Medicaid.  Or delays in grants to state, such as for education.  More indirectly, if financial market concerns extend beyond U.S. treasuries, this could increase borrowing costs to state and local governments as well.

 In short, while most of the focus has been on the impact of the debt impasse on federal spending, it is important to recognize that this will also likely “trickle down” on states in the form of cash-flow / liquidity constraints. 

Here’s hoping that by the time this blog is posted, it is already out-of-date.

Chicken Little Meets the Boy Who Cried Wolf: Some Thoughts on the Debt Ceiling Debate

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Jul 25, 2011

If you’ve been following the news regarding the debt ceiling (and how could you not?), then you have probably been wondering who to believe.  Depending on who you listen to, a failure to raise the debt ceiling is either Chicken Little or the Boy Who Cried Wolf.

Phrases such as Armageddon, lights out and playing with fire are being used by Democrats (including, but not limited to, treasury secretary Geithner and President Obama) to convey a sense of urgency to the American people in an attempt to force the Republicans to raise the debt ceiling.  On the Republican side, the Tea Party wing of the party has made a credible threat to not raise the debt ceiling unless accompanied by substantial spending reductions (Here I should confess my error in a post earlier this year suggesting it was difficult to make the threat credible.  They have done so.)  Lately, I have heard some on the right begin to question whether a failure to raise the debt ceiling would really be all that bad.

Let me be clear – this is a dangerous game we are playing.  But it is dangerous on both sides.  Democrats are right that a failure to raise the debt ceiling could have a serious negative impact on an already-fragile and weak economic recovery.  Republicans are right that a failure to get our deficits and government spending under control could have even more serious consequences for our economy over the long-run. 

Should the deadline set by Secretary Geithner of August 2nd come with no deal reached, the government will not be able to do any additional net borrowing.  Thus, the United States be left in a position to ‘prioritize their payments.’  Indeed, President Obama created a political firestorm by suggesting that Social Security payments might be delayed.  This prompted Republicans to remind the President that we have a Social Security Trust Fund.  This struck me as the ultimate irony, given that Republicans (including me) have spent the past two decades in the Social Security debate trying to remind everyone why the Trust Funds are little more than an accounting device!  But I digress …    

So, what would happen?  If the debt ceiling is reached, the federal government will be placed in a position where they will have to choose whom to pay with the tax revenue coming available.  Interestingly, the Republicans have been quick to name things that should NOT be touched.  As one of many examples, Tim Pawlenty, a Republican presidential candidate, said “the outside creditors should be paid first, followed by the military.”  Others have suggested that we also take Social Security and Medicare off the table in the short-run.  But Social Security, Medicare, military and debt-servicing make up an enormous share of our cash outflows, so if we try to balance on the backs of everything else, the cuts would have to be that much more severe.

Regardless of what we choose to take the hit, the reaction from financial markets would likely be quite bad.  If the rating agencies downgrade U.S. government debt, the government’s borrowing rate will rise.  The value of bonds will fall, as will stock prices.  This negative wealth shock that would reduce consumption, a key driver of economic activity.  Consumer confidence would take a hit, reducing economic activity even further.  Interest rates on variable rate mortgages, car loans, student loans, and business loans would increase.  If government debt is downgraded enough, then financial institutions (such as insurance companies, banks, etc) might be subject to additional capital requirements (given that a large share of their assets are held in supposedly risk-free treasuries).  This could make even less money available for financial institutions to loan out or invest.  In short, higher interest rates and tighter credit can act like sand in the gears of the economy.  Remember Fall 2008?   

So, why would anyone in their right mind even threaten a default, let alone follow-through on it?  Because, sadly, we appear to need the threat of a really bad economic event to prevent us from precipitating another, even larger, bad economic event down the road.  In a sign of just how dysfunctional our government has become, it seems that Washington is unable to get its act together and address our very serious long-term fiscal problems.  It is not out of a lack of understanding – it is, after all, common knowledge in Washington that deficits are out of control.  It is a lack of political will, political courage, and leadership.

So, some are betting that the threat of default is what we need to get people serious about long-term deficit reduction.  And they have certainly succeeded in getting deficit reduction on the political agenda with an urgency that we have not seen in many years.  If they succeed in avoiding default by getting bipartisan agreement to substantial deficit reduction, this may go down as one of the most brilliant political and economic moves of our lifetime.  But if the gridlock continues and the two sides are unable to reach an agreement, we could be left with a large negative financial market shock, accompanied by the even greater realization that our government is incapable of getting its fiscal house in order.  A really bad outcome for an economy already struggling to revive. 

Many months ago, I saw Alan Greenspan on a Sunday morning talk show.  When asked if we would ever solve our fiscal problems, he said, “yes.”  Then after a short pause, he said something along the lines of: “the question is whether we will do so before or after a bond market crisis.”

Let’s hope it is before next week.

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.

Would a 28% Limit on Itemized Deductions be Fair?

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Jul 11, 2011

About two weeks ago, I was contacted by a company that was interested in talking to me for 30 minutes about what information I found valuable as a member of an Audit Committee for a large corporate board.  Their creative (and effective) approach to getting me to take 30 minutes out of my busy schedule to talk to them was to offer to make a $300 charitable donation to any charity of my choosing.  Because I am currently volunteering on a capital campaign to help a local non-profit institution undertake a major capital project, I figured this was a worthwhile effort.  I could help this organization deliver better information to board members, and my favorite non-profit would benefit financially. 

There are two ways to treat this transaction on my taxes.  First – which is the easy route which I suspect most people take – would be to simply ignore this transaction on my taxes, with the rationale being that I received no money.  The second way (and the one that may be the technically correct way to do it – but I will have to check with my accountant!) is to report it as $300 of taxable income, and then also report a $300 tax deductible contribution to the non-profit.  Either way, my tax liability is unchanged by having spent 30 minutes doing this – the charitable deduction exactly offsets any income.

But if the Obama Administration and Congressional Democrats have their way, and if I were to perform such a civic act in the future, I would owe about $21 in taxes on this transaction, even though I never received a penny.  Why?

As reported in the July 5 Wall Street Journal article by John McKinnon and Carol Lee, Democrats would like to impose a cap on the value of itemized deductions.  Instead of allowing me to offset my income at my 35% marginal tax rate, they would cap it at 28%.  So, now, I would pay a 35% tax on the $300, and then only get to deduct 28% of $300.  Thus, I pay the difference (7% of $300) in taxes, even though I never saw the money.

Is this fair? 

The main point I want to make with this blog is that “fairness” is not a well-defined economic concept.  It does seem “unfair” to me that I may now have to send the government another $21 just because I decided to do spend 30 minutes helping out these two organizations, even though I did not personally profit from it.  Interestingly, however, the Democrats are justifying this policy solely on the basis of “fairness.”  As the WSJ article states: “Democrats argue that high-income people unfairly benefit from any given tax deduction now more than middle-class people do, just because they are in higher tax brackets.”

I find the Democrats’ position is a difficult one.  We have a progressive tax system that imposes higher marginal tax rates on higher incomes.  Basically, the rich pay more, on average.  So then we decide – for reasons that may be the subject of a future post – that some activities (such as charitable contributions) should be tax deductible.  But then we argue that it is not fair to give a tax deduction to the high earners because they “benefit” more.  But the only reason they “benefit” more from the tax deduction is because we have imposed a higher tax on them to begin with!  So in the name of fairness, we levy higher taxes on the rich, and then in the name of fairness we complain about its implications?

My bottomline is that “fairness” is not actually a well-defined concept.  It is also not a topic on which the economics profession has any comparative advantage in addressing.  We are much better at understanding the impact of policy on incentives, and even on how a policy affects resource distribution (a topic which is presumably related to many concepts of fairness).  So I am always a bit wary when people make unequivocal statements about fairness to justify a policy. 

My treatment of this topic is, admittedly, quite incomplete.  Among the issues I have not addressed, but may in future posts:   1) Is it desirable to allow tax deductions for certain activities at all?  2) Do we think we have too much or too little in the way of charitable giving?  3) What impact would such a policy have on the charities that rely on voluntary donations?  Stay tuned …