Topic: Tax and Budget Policy

Nothing to Celebrate in Obama’s Budget

President Obama released his fiscal year 2015 budget request today. Sadly, for those who support smart, sensible budgeting, the president’s budget is nothing to celebrate. The budget increases spending and fails to tackle the main driver of our budget problem—entitlement spending. All deficit reduction included in the budget is from revenue increases, not spending cuts.

In coming days, we’ll be analyzing the president’s budget in detail, but here are the top-line numbers:

1. The president’s budget proposes spending more than the Ryan-Murray budget deal passed in December. Under the agreement reached by Congressman Ryan and Senator Murray, and supported by the president, discretionary spending for fiscal year 2015 should be $1,014 trillion. The president’s budget includes a section that bumps that up by $56 billion, paid for mostly by tax increases.

2. Over the 10-year budgetary window, the president spends $171 billion more than Congressional Budget Office (CBO) baseline. The budget also runs large deficits every single year.

3. According to Obama’s budget, the federal government will collect $3.3 trillion in tax revenue in 2015, more than any other year in history. The budget includes $650 billion in new revenue though various tax hikes. The president’s Office of Management and Budget also made rosier assumptions about economic growth over the next 10 years than did the CBO. As a result, the president’s budget would collect an additional $3.1 trillion in revenue over 10 years than CBO assumes.

Will Venezuela Be Next?

Last year, Nicholas Krus and I published a chapter, “World Hyperinflations”, in the Routledge Handbook of Major Events in Economic History. We documented 56 hyperinflations – cases in which monthly inflation rates exceeded 50% per month. Only seven of those hyperinflations have savaged Latin America (see the accompanying table).

At present, the world’s highest inflation resides in Latin America, namely in Venezuela. The Johns Hopkins – Cato Institute Troubled Currencies Project, which I direct, estimates that Venezuela’s implied annual inflation rate is 302%. Will Venezuela be the eighth country to join the Latin American Hall of Shame? Maybe. But, it has a long way to go.

The Hanke-Krus Hyperinflation Table
Latin American edition

Country Month With Highest Inflation Rate Highest Monthly Inflation Rate Equivalent Daily Inflation Rate Time Required for Prices to Double
1. Peru Aug. 1990 397% 5.49% 13.1 days
2. Nicaragua Mar. 1991 261% 4.37% 16.4 days
3. Argentina Jul. 1989 197% 3.69% 19.4 days
4. Bolivia Feb. 1985 183% 3.53% 20.3 days
5. Peru Sep. 1988 114% 2.57% 27.7 days
6. Chile Oct. 1973 87.6% 2.12% 33.5 days
7. Brazil Mar. 1990 82.4% 2.02% 35.1 days

Source: Steve H. Hanke and Nicholas Krus (2013), “World Hyperinflations”, in Randall Parker and Robert Whaples (eds.) Routledge Handbook of Major Events in Economic History, London: Routledge Publishing.

Grading the Camp Tax Reform Plan

To make fun of big efforts that produce small results, the Roman poet Horace wrote, “The mountains will be in labor, and a ridiculous mouse will be brought forth.”

That line sums up my view of the new tax reform plan introduced by Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee.

To his credit, Chairman Camp put in a lot of work. But I can’t help but wonder why he went through the time and trouble. To understand why I’m so underwhelmed, let’s first go back in time.

Back in 1995, tax reform was a hot issue. The House Majority Leader, Dick Armey, had proposed a flat tax. Congressman Billy Tauzin was pushing a version of a national sales tax. And there were several additional proposals jockeying for attention.

To make sense of the clutter, I wrote a paper for the Heritage Foundation that demonstrated how to grade the various proposals that had been proposed.

Chairman Murray’s Memo: More of the Same

Today, Senate Budget Chairman Patty Murray sent her caucus a memo on the country’s fiscal outlook. She details the “$3.3 trillion in deficit reduction put in place over the last few years;” a likely refrain in President Obama’s budget next week. However, Chairman Murray’s memo leaves much to be desired.

The first section of Murray’s memo highlights the various ways that the deficit has been reduced over the last several years by Congress and the President. The bulk of savings are from the discretionary spending caps put into place by the Budget Control Act (BCA) of 2011. Another large share of deficit reduction came from $727 billion in tax increases over the last several years. All told, Murray counts $3.3 trillion in deficit reduction. This is an incredibly small step to tackling our $4 trillion budget.

But after detailing all of the great things this fiscal restraint is doing for the country, Chairman Murray completely turns course. Instead of detailing additional ways to cut spending and continue these marginal improvements, she starts a laundry list of needed government “investments”—spending programs. She calls for more spending on infrastructure, jobs programs, a minimum wage increase, and increased funding for research and development.

Also notably, she also does not include future sequester cuts in her numbers; an implicit acknowledgement that she does not plan to keep those promised cuts.

Chairman Murray’s memo also fails to acknowledge the impending fiscal crisis. According to the most recent Congressional Budget Office (CBO) report, the country’s debt and deficit are stable for the next few years, but by 2017 they increase dramatically again. CBO expects the deficit to rise to 4% of GDP by the end of the decade. Even though, revenues as a percent of GDP will be close to historical levels, Chairman Murray calls for more tax hikes, ignoring the real driver of our fiscal issues: spending.

The refrain from many over the last year has been that the deficit is back under control, and that Congress should go back to wildly spending. Chairman Murray’s memo follows that path. It fails to acknowledge the need for fiscal restraint and sets the stage for next week’s release of the President’s budget.

Bank Tax Is Wrong “Fix” for Too-Big-To-Fail

Chair of the House Ways and Means Committee Dave Camp is soon to roll out a plan for comprehensive tax reform. He is to be commended for doing so. Our tax code is an absolute mess with incentives for all sorts of bad behavior. Early reports suggest, however, that Congressman Camp will also include a “bank tax” to both raise revenue and address the “Too-Big-To-Fail” (TBTF) status of our nation’s largest banks. While the evidence overwhelmingly suggests to me that TBTF is real, with extremely harmful effects on our financial system, I fear Camp’s approach will actually make the problem worse, increasing the market perception that some entities will be rescued by the federal government.

Bloomberg reports the plan would raise “would raise $86.4 billion for the U.S. government over the next decade…would likely affect JPMorgan Chase & Co, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.” The proposal would do so by assessing a 3.5 basis-point tax on assets exceeding $500 billion.

While standard Pigouvian welfare analysis would recommend a tax to internalize any negatives externalities, TBTF is not like pollution, it isn’t something large banks create. It is something the government creates by coming to their rescue. I don’t see TBTF as a switch, but rather a dial between 100 percent chance of a rescue and zero. By turning the banks into a revenue stream for the federal government, we would likely move that dial closer to 100 percent–and that is in the wrong direction. For the same reason, I have opposed efforts to tax Fannie Mae and Freddie Mac in the past. The solution is not to bind large financial institutions and the government closer together, as a bank tax would, but to further separate government and the financial sector. Just over a year ago, I laid out a path for doing so in National Review. Were we to truly end bailouts, limiting government is the only way to get that dial close to zero.   

If we want to use the tax code to reduce the harm of financial crises, then we should focus on reducing the preferences for debt over equity, which drive so much of the leverage in our financial system.  I’ve suggest such here in more detail. There are also early reports that Camp’s plan will reduce some of these debt preferences. Let’s hope those remain in the plan.

Folly of Federal Flood Insurance

Subsidized flood insurance is one of the many federal programs that is counter to both sound economic policy and sound environmental policy. Congress created the National Flood Insurance Program (NFIP) in 1968 to help homeowners in flood-prone areas purchase insurance. The FEMA-run program covers floods from river surges and storms on the seacoasts.

In recent years, the NFIP has gone hugely into debt and it may be bailed-out by taxpayers at some point. The program has encouraged people to build homes in areas that are too hazardous to safely occupy. It has encouraged towns to expand development in flood-prone areas. And the program undermines constitutional federalism by prompting the federal government to reach its regulatory tentacles into local zoning issues.

The NFIP subsidizes wealthy people with multiple payouts after their homes on the seacoasts are repeatedly destroyed. The program is very bad policy—a seemingly good idea to policymakers in the 1960s that has ended up creating growing distortions.

When I started reading about the NFIP recently, I was surprised to learn that Congress made sensible reforms to it in 2012 under the Biggert-Waters Act. The best reform would be a complete repeal of the NFIP, but in the meantime the 2012 law was a good start at reducing the program’s costs and distortions.

Alas, the prospect of Congress staying on a pro-market, pro-environment reform path was apparently too good to be true. No sooner had the ink dried on the 2012 law than members of Congress began trying to reverse the reforms.

This week, Congress will be voting on a bill that backtracks on the 2012 reforms. I have not studied the details of the new bill, but Diane Katz at the Heritage Foundation has penned a nice overview.

Congress against Budget Reform: Voting to Hike Subsidies for People Who Build in Flood Plains

Uncle Sam is essentially broke.  But the federal government keeps spending.  The House is voting this week on a measure already adopted by the U.S. Senate to suspend money-saving reforms adopted less than two years ago.

In 1968 Congress created the National Flood Insurance Program, shifting the cost of disasters from people who chose to live in flood-prone areas to taxpayers who don’t.  Over time Congress kept cutting premiums.  By 1982 two-thirds of participants received a subsidy.

NFIP turned into foolishness squared.  The first cost is financial:  the federal government keeps insurance premiums low for people who choose to build where they otherwise wouldn’t.  The Congressional Research Service figured that the government charges about one-third of the market rate for flood insurance.  The second cost is environmental:  Washington essentially pays participants to build on environmentally-fragile lands that tend to flood. 

Uncle Sam also has a propensity to spend billions more to rebuild public buildings and infrastructure in flood zones. 

Although not every NFIP beneficiary is wealthy, CRS noted:  “Some critics point out that the costs—financial risk and ecological damage—are widely distributed to taxpayers across the country and the benefits, by contrast are disproportionately enjoyed by wealthy counties and by owners of vacation homes.”

NFIP’s overall liability is $1.3 trillion.  Today total program debt is about $25 billion.  Economists Judith Kildow and Jason Scorse warned that “the flood insurance program is a fiscal time bomb for the government.” 

So disastrous were the program’s finances that even Congress felt the need to act.  In July 2012 legislators approved the Biggert-Waters Flood Insurance Reform Act in an attempt to make the NFIP more accurate, efficient, and solvent.  For different properties rates were increased and subsidies were cut.  Overall, the legislation was expected to save about $25 billion.

The amendment worked—too well.  Insurance bills began increasing.  People used to living well at taxpayer expense complained to their legislators.  Interest groups which profit from property sales also raced to Capitol Hill,  

So now reform co-sponsor Rep. Maxine Waters (D-Ca.) is pushing to delay the reforms until 2018.  Of course, in 2018 no one will be more willing to pay higher premiums, and undoubtedly will again lobby for further relief from Congress.

Explained Waters:  “Never in our wildest dreams did we think the premium increases would be what they appear to be today.”  Her new legislation, backed by a mix of Republicans and Democrats, would bar increases in premiums and reductions in subsidies for some properties, restore earlier subsidies for others, and mandate an “affordability study.”

Said Waters:  “neither Democrats nor Republican envisioned it would reap the kind of harm and heartache that may result from this law.”  She was echoed by Nicholas Pinter, a professor at Southern Illinois University, who advocated reforms but also “compassion for Americans living on flood-prone lands.” 

As I point out in my new article on Forbes online: 

Actually, those people need to be held responsible for their actions.  Compassion should be accorded taxpayers, who have suffered for decades.  Mississippi Commissioner of Insurance Mike Chaney said the NFIP should not make up its shortfall from homeowners who “simply followed the rules.”  But if not them, who?  After all, they received the benefits of the subsidized insurance.

At the end of January, the Senate voted to effectively kill the 2012 reform.  That would “return the program to a state of insolvency,” Shai Akabas of the Bipartisan Policy Center told the New York Times

The Republican House leadership has approved a vote on a companion measure.  Even the White House criticized Congress’ potential U-turn.

In fact, the 2012 measure didn’t go far enough.  Congress should eliminate federally-subsidized flood insurance—entirely.  There is no justification for turning Uncle Sam into a back-stop for wealthy vacationers and other privileged recipients of federal largesse.

Like Uncle Sam, NFIP is broke.  It should be killed, not reformed.  Legislators should start exhibiting compassion for American taxpayers.