Topic: Tax and Budget Policy

Right-to-Know Payroll Tax Reform

I met with a group of House Republicans last week to talk about tax reform. Ways and Means chairman Kevin Brady is laying the groundwork for a major tax restructuring next year, and so GOP members are boning up on reform ideas. I discussed income tax reforms with the members, including the creation of Universal Savings Accounts. And, on payroll taxes, I proposed reviving the Right-to-Know National Payroll Act, a bill that passed the House back in 2000 but died in the Senate.

The federal payroll (or FICA) tax that funds Social Security and part of Medicare imposes a huge burden on workers and the self-employed. Liberals are right when they note that the 15.3 percent tax costs moderate-income people far more than the income tax does. In addition to the large burden, the problem with the payroll tax is that half of it (7.65 percent) is collected from employers and hidden from citizens because it does not appear on worker paystubs or annual IRS W-2 forms.

Economists agree that the “employer” half of the payroll tax actually falls on employees in the form of lower wages. Thus the tax reduces wages of American workers by $550 billion a year without them even knowing it. For transparency in taxation, Congress should change the administration of the payroll tax so that the full 15.3 percent is clearly visible on worker paystubs and W-2 forms.

Economic Lesson from Europe: Higher Tax Rates Are a Recipe for More Red Ink

We can learn a lot of economic lessons from Europe.

Today, we’re going to focus on another lesson, which is that higher taxes lead to more red ink. And let’s hope Hillary Clinton is paying attention.

I’ve already made the argument, using European fiscal data to show that big increases in the tax burden over the past several decades have resulted in much higher levels of government debt.

But let’s now augment that argument by considering what’s happened in recent years.

There’s been a big fiscal crisis in Europe, which has forced governments to engage in austerity.

But the type of austerity matters. A lot.

Here’s some of what I wrote back in 2014.

…austerity is a catch-all phrase that includes bad policy (higher taxes) and good policy (spending restraint). But with a few notable exceptions, European nations have been choosing the wrong kind of austerity (even though Paul Krugman doesn’t seem to know the difference).

And when I claim politicians in Europe have chosen the wrong kind of austerity, that’s not hyperbole.

Uncle Sam the Middleman

The federal government funds hundreds of subsidy programs for state, local, and private activities, such as programs for housing and economic development. State and local governments, businesses, charities, and individuals could fund such local activities by themselves without federal aid. But America is increasingly kicking local activities up to the federal government, and so Uncle Sam the Middleman keeps growing.

How much does Uncle Sam the Middleman cost? As a rough estimate, the federal bureaucracy represents about 10 percent of the costs of the projects it gets involved in.

I described how U.S. Department of Agriculture (USDA) rural programs fund such activities as local broadband, clam fishing, energy projects, apartment construction, and street paving. USDA rural programs will cost federal taxpayers $6.5 billion in 2016. Most of the money will go to the people and businesses that are subsidized, but a portion will end up in the hands of federal bureaucrats.

The federal budget appendix shows that there are 5,000 workers in the USDA’s Rural Housing Service, Rural Utilities Services, and Rural Business Cooperative Service. Based on data in the appendix, they earn an average annual salary of about $73,000 and receive benefits of $25,000. They earn less than other federal workers, but still far more, on average, than private sector workers. Fun fact: these 50 rural program administrators earn an average annual salary of about $135,000.

All and all, workers in the three rural agencies impose an annual cost on taxpayers of about $490 million. But these folks need office space, telephones, travel expenses, and supplies to do their paperwork. Based on data in the appendix, that cost is roughly $38,000 per worker for the rural programs, or $190 million a year.

Thus, of the $6.5 billion taxpayer cost of the rural programs, roughly $680 million does not get to the broadband companies, the clam fisherman, and street paving contractors—it goes into the pockets of the federal middlemen.

Why is this important? Because politicians and federal program supporters often talk as if federal funding of local activities is a free boost to the economy. But it is not free for a lot of reasons. Most directly, federal programs are not free because Uncle Sam the Middleman carves off for itself about 10 percent of the money flowing through it.

The USDA rural programs spent $651,000 on an arts center in Bozeman. But about $65,000 would not have gotten to the arts center; it would have been consumed by the federal bureaucracy. Rather than raising the money locally, Bozeman citizens essentially filled in their 1040s, sent their income tax money to Washington, and then had to lobby federal officials to get some of it back for their arts center. Such roundabout financing of local projects makes no sense.

For more on the problems of America’s roundabout financing system, see here.

We’ll Never Improve the Tax System by Clinging to Partisan Folklore

top marginal tax rates over time

A stubborn myth of the pro-tax left (exemplified by Bernie Sanders) is that the Reagan tax cuts merely benefitted the rich (aka Top 1%), so it would be both harmless and fair to roll back the top tax rates to 70% or 91%.

Nothing could be further from the truth. Between the cyclical peaks of 1979 and 2007, average individual income tax rates fell most dramatically for the bottom 80%  of taxpayers, with the bottom 40 percent receiving more in refundable tax credits than paid in taxes.  By 2008 (with the 2003 tax cuts in place), the OECD found the U.S. had the most progressive tax system among OECD countries while taxes in Sweden and France were among the least progressive.

What is commonly forgotten is that before two across-the-board tax rate reductions of 30% in 1964 and 23% in 1983, families with very modest incomes faced astonishingly high marginal tax rates on every increase in income from extra work or saving (there were no tax-favored saving plans for retirement or college).

From 1954 to 1963 there were 24 tax brackets and 19 of those brackets were higher than 35%.  The lowest rate was 20% -double what it is now.  The highest was 91%.

High and steeply progressive marginal tax rates were terrible for the economy but terrific for tax avoidance. Revenues from the individual income tax were only 7.5% from 1954 to 1963 when the highest tax rate was 91%, which compares poorly with revenues of 7.9% of GDP from 1988 to 1990 when the highest tax rate was 28%. 

Wonkblog’s Debt Denial

A Time article by James Grant warning about rising federal debt has prompted pushback by columnists questioning whether debt is really so bad. At the Washington Post, Wonkblog columnist Matt O’Brien says “there’s no reason to cut the debt today.” Fellow Wonkblog columnist Max Ehrenfreund suggests that Grant’s figure of $42,998 government debt per person overstates the problem.

O’Brien suggests that the only reason to fear debt would be if it was leading to a financial crisis, but it isn’t because interest rates are low. But O’Brien neglects to mention that interest rates may rise substantially in coming years. CBO projects that as rates rise, federal interest costs will triple from $253 billion this year to $839 billion by 2026.

As for Ehrenfreund, he is right that $42,998 overstates the debt problem because it does not take into account our future rising population. At the same, however, $42,998 understates the problem because each year the government adds more debt. Over the next 10 years, the U.S. population will grow 8 percent, but the CBO says federal debt will rise 69 percent. So Grant’s simple debt metric will increase over time.

Other than possibly causing a financial crisis, rising federal debt creates other harms:

Largest Federal Government Agencies

We’ve updated the charting tool at with the latest data. You can plot spending on hundreds of federal agencies and programs in constant, or inflation-adjusted, dollars. The charts cover 1970 to 2016.

Which are the largest federal government agencies, and how much have they grown? The following series of seven charts captured from the charting tool shows the 21 largest agencies in order by size.

The first chart shows that Defense, Health and Human Services, and the Social Security Administration used to vie for top spot as the largest agency. But Defense is now being left in the dust, as the latter two entitlement-dispensing agencies gobble up ever more tax dollars.

Tax Reform at Ways and Means

A number of House Republicans have testified to the Ways and Means Committee about their ideas for overhauling the tax code. Rep. Roger Williams testified about his plan this week. And Reps. Michael Burgess, Devin Nunes, and Robert Woodall presented their plans a couple weeks ago.

Here are a few notes:

Michael Burgess Flat Tax. Rep. Burgess testified in favor of a classic Hall-Rabushka flat tax, which is the plan that has been supported by Steve Forbes and Dick Armey. The tax is named after economists Robert Hall and Alvin Rabushka, who is an adjunct scholar at Cato.

The Burgess plan would have a 19 percent rate (dropping to 17 percent), a large standard deduction ($32,000 for a married couple), and large child deductions ($7,000 per child). My preference would be for a lower rate with a smaller standard deduction, but the Burgess plan is generally excellent.

The flat tax would vastly simplify the tax code. Individuals would be able to file their tax return on a postcard because the plan would abolish nearly all deductions, exemptions, and credits, and individuals would be generally only taxed on their labor income. All capital income would be taxed at the business level at the same 19 or 17 percent rate.

Business taxation would have a simplified cash-flow structure, and companies would immediately write-off capital investment. Complex income tax concepts such as depreciation, amortization, and capital gains would be abolished.

The Burgess tax would eliminate the current tax code bias against savings and investment, which is a key weakness of income taxation. With an economically neutral base and a low rate, the Burgess flat tax would be very pro-growth.

Devin Nunes Business Tax. The Nunes proposal is essentially the business part of the Hall-Rabushka flat tax, but with a 25 percent rate. This is a cash-flow tax, meaning that accrual accounting and noncash concepts such as depreciation would be scrapped. Business investment would be expensed.