Topic: Tax and Budget Policy

Obama’s Transportation Plan

President Obama proposed an expansive spending plan for highways, transit, and other infrastructure in his 2016 budget.

Here are some of the problems with the president’s approach:

  • Misguided Funding Source. The president proposes hitting U.S. corporations with a special 14 percent tax on their accumulated foreign earnings to raise $238 billion. This proposal is likely going nowhere in Congress, and it is bad economic policy. The Obama administration seems to view the foreign operations of U.S. companies as an enemy to be punished, but in fact foreign business operations generally complement U.S. production and help boost U.S. exports.
  • Increases Spending. The Obama six-year transportation spending plan of $478 billion is an increase of $126 billion above current spending levels. Instead of increasing federal spending on highways and transit, we should be cutting it, as it is generally less efficient that state-funded spending. To close the Highway Trust Fund (HTF) gap, we should cut highway and transit spending to balance it with current HTF revenues, which mainly come from gas and diesel taxes.
  • Increases Central Control. The Obama plan would increase federal subsidies for freight rail and “would require development of state and regional freight transportation plans,” according to this description. But freight rail has been a great American success story since it was deregulated by President Jimmy Carter in 1980. So let’s not reverse course and start increasing federal intervention again. Let’s let Union Pacific and the other railroads make their own “plans;” we don’t need government-mandated plans.
  • Undermines User Pays. For reasons of both fairness and efficiency, it is a good idea to fund infrastructure with charges on infrastructure users. In recent decades, the HTF has moved away from the original user-pays model of gas taxes funding highways, as funds have been diverted to mass transit, bicycle paths, and other activities. Obama would move further away from user pays, both with his corporate tax plan and with his proposed replacement of the HTF with a broader Transportation Trust Fund.
  • Expands Mass Transit Subsidies. The Obama plan would greatly increase spending on urban bus and rail systems. But there is no proper federal role in providing subsidies for such local activities. Indeed, federal transit subsidies distort efficient local decision making—the lure of “free” federal dollars induces local politicians to make unwise and wasteful choices. Arlington, Virginia’s million-dollar bus stop is a good example.

For background on the transportation battle heating up in Congress, see my articles here and here. And see the writings of Randal O’Toole, Robert Poole, Emily Goff, and Ken Orski.

And you can check out the writings of Robert Puentes of Brookings, who joined me on C-Span today to discuss these issues.

When Mean-Tested Benefits Rose, Labor Force Participation Fell

The U.S. job market has tightened by many measures – more advertised job openings, fewer claims for initial unemployment insurance, substantial reduction in long-term unemployment and the number of discouraged workers.  Yet the percentage of working-age population that is either working or looking for work (the labor force participation rate) remains extremely low.  This is a big problem, since projections of future economic growth are constructed by adding expected growth of productivity to growth of the labor force.

Why have so many people dropped out of the labor force?  Since they’re not working (at least in the formal economy), how do they pay for things like food, rent and health care?

One explanation answers both questions: More people are relying on a variety of means-tested cash and in-kind benefits that are made available only on the condition that recipients report little or no earned income.   Since qualification for one benefit often results in qualification for others, the effect can be equivalent to a high marginal tax rate on extra work (such as switching from a 20 to 40 hour workweek, or a spouse taking a job).  Added labor income can often result in loss of multiple benefits, such as disability benefits, supplemental security income, the earned income tax credit, food stamps and Medicaid. 

This graph compares annual labor force participation rates with Congressional Budget Office data on means-tested federal benefits as a percent of GDP.  The data appear consistent with work disincentives in federal transfer payments, labor tax rates and refundable tax credits.

Rising Cost of Net Interest

One of the largest and fastest growing items in President Obama’s new budget is often overlooked. Net interest expenses will skyrocket over the next decade, growing by 250 percent.

The Congressional Budget Office (CBO) continues to warn about the rising burden of federal interest payments. Over the next decade, CBO expects net interest expenses will be the third fastest growing budget item. Net interest represents 24 percent of the increase in federal spending during that time period.

Interest expense will increase due to two factors: higher interest rates and larger outstanding debt.

First, federal borrowing rates are currently well below average. In 2014 the 10-year Treasury rate averaged 2.5 percent according to CBO. Since 1990 the 10-year Treasury has averaged approximately 5 percent. Lower-than-normal interest rates are currently keeping the government’s borrowing expenses low, but interest rates are expected to return to historic averages.

Second, the government has added federal debt quickly. Debt held by the public has grown by 120 percent since 2008, and that growth is expected to continue.

As a result of these two factors, CBO predicts that net interest will grow from 1.3 percent of gross domestic product in 2015 to 3 percent in 2025.

Federal Infrastructure: Often Low Value

President Obama’s budget would raise taxes to fund a $478 billion infrastructure spending plan for highways, transit, and other items. The budget (on page 26) cites an International Monetary Fund study that “highlights the importance of choosing high-efficiency infrastructure projects based on rigorous benefit-cost analysis.”

Unfortunately, that is not the type of “choosing” that the federal government usually does, based on more than a century of experience. As one historical example, here is what I found out about the choosing of federal dam projects in the wake of the 1902 Reclamation Act:

To secure support from the western states, the 1902 legislation required that 51 percent of the revenue from federal land sales in each state be spent on Reclamation projects within that state. However, there wasn’t necessarily a relationship between land-sale revenues and the locations of the best projects. This requirement “seriously compromised the ability of government engineers to select projects objectively.”

After the Reclamation Act passed, the Republican Party saw political advantage in quickly proposing a large number of projects in as many states as possible. This rush to launch projects for political reasons reduced efficiency. By 1907 Reclamation had requested and received congressional approval for 24 projects, with every western state receiving at least one. “Most of the projects were begun in great haste with little attention paid to economics, climate, soil, production, transportation, and markets.”

Much of the federal government’s history with infrastructure is one of pork barrel spending, environmental harm, fudged cost-benefit analyses, and cost overruns. Of course, there are mistakes and waste in state, local, and private infrastructure as well, but federal spending is usually worse for basic structural reasons. Those structural reasons—such as parochial politics and lack of oversight—are likely worse now than in 1902.

The President’s 2016 Budget Request

The president released his budget request this morning. As expected, his plan is heavy on new spending and new taxes, and very light on structural reforms.

Overall, the president says that he would collect $2.994 trillion more in revenue from 2016 to 2025 than the Congressional Budget Office (CBO) baseline projections. He would also spend $1.028 trillion more during that same time frame.

The excess revenue would result in slightly smaller deficits than the CBO projected during this period. The president’s budget predicts that debt held by the public will equal 73.3 percent of gross domestic product in 2025, compared to 78.7 percent projected by the CBO.

However, the president’s budget assumes faster economic growth than the CBO does, which makes the president’s budget numbers look rosier. If GDP was constant between the two proposals, the president’s debt-to-GDP ratio in 2025 would increase to 74.2 percent. This is still less than the CBO’s projections, but it comes at the expense of higher taxes.

Cutting Spending Is the Best Approach

On Monday, the White House will release President Obama’s budget proposal for Fiscal Year 2016. The president is expected to reemphasize his previous fiscal approach of higher spending coupled with higher taxes, while completely ignoring the country’s long-term fiscal problems.

A new study published by the National Bureau of Economic Research (NBER) provides evidence of the best way to solve those problems, should the president decide to tackle the nation’s fiscal mess. The study, by Alberto Alesina, Omar Barbiero, and others, tries to answer one central question: What is the best way for a country to rebalance policy to solve a fiscal crisis?  

The study looked at Organization of Economic Cooperation and Development member countries and their response to the financial crisis from 2009 to 2013. Following the crisis, many of those countries became burdened by large amounts of debt and deficit as a result of rising spending and falling revenues. Government spending grew to an average of 43 percent of gross domestic product (GDP) within the European Union.

With a fiscal crisis on the horizon, many of the countries turned to so-called “austerity” measures in order to promote economic growth. Some countries adopted policies that focused on increasing revenue to close budget gaps, while others focused spending cuts. Researchers distinguished between fiscal plans based on spending cuts and those based upon tax increases.

The researchers found that spending cuts, not tax increases, are the best way to resolve a fiscal crisis. According to the researchers, “Fiscal adjustments based upon cuts in spending appear to have been much less costly, in terms of output losses, than those based upon tax increases.” Tax-based fiscal plans are an inefficient solution to fiscal problems in the long-term. An average tax-based plan with a size of 1 percent of total GDP was shown to shrink the economy by almost twice that amount over the next three years.

The NBER study provides valuable insight regarding the effectiveness of different types of fiscal adjustment plans. Fiscal plans emphasizing cuts in spending are more successful in promoting economic growth in the long term.

Thanks to Kristina Pepe for her excellent research assistance on this piece.

Pentagon Spending and Bureaucratic Bloat

There are major spending battles on the Washington agenda this year, including over the defense budget. Congress needs to decide whether to stick with capped spending levels agreed to in 2011, or allow its past restraint efforts to unravel.

Republican defense hawks want to bust the spending caps, while the small-government wing of the party wants to hold the line. Rep. Justin Amash (R-Mich.) told the Wall Street Journal, “We’ve been spending too much on defense for years because we have a lot of waste within the Department of Defense … There’s room to cut, and I think we are perfectly capable of staying within the sequester caps.” Sen. Rand Paul (R-Ky.) noted, “To defend ourselves, we need a lean, mean fighting machine that doesn’t waste money on a bloated civilian bureaucracy.”

Amash and Paul’s position is buttressed by a new GAO study on the management bloat in Department of Defense (DoD) headquarters.

It is also buttressed by looking at DoD civilian and uniformed employment levels. The chart below shows that civilian DoD employment has grown 105,000 since 2001, while uniformed employment has grown just 22,000. Based on numbers in the chart, the ratio of bureaucrats-to-soldiers has increased from 47 percent in 2001 to 54 percent in 2014. But with the advance of computer power and other technologies, one would think that the bureaucratic overhead costs of our fighting force would be falling over time, not increasing.

How much could we save by improving bureaucratic efficiencies, and cutting the number of Pentagon civilians by at least the apparent excess of about 100,000? Annual pay and benefits for federal civilians is about $120,000 a year, so we could save roughly $12 billion a year by trimming this aspect of Pentagon bloat.

All data from the “Analytical Perspectives” sections of the FY2003 and FY2015 federal budgets. Data for 2014 are OMB estimates.