Tax and Budget Policy

September 23, 2020 3:05PM

Federal Spending and Deficits

Spending and deficits used to be a battleground in federal elections as each party suggested reforms and blamed the other for fiscal irresponsibility. Candidates proposed tax and spending plans, and reporters examined whether the figures added up and what the impact might be.

These days, the leaders of both parties are ignoring the fiscal hurricane heading for landfall on our economy, while reporters rarely probe the politicians about the coming storm.

The Congressional Budget Office has released its latest outlook showing where the budget and economy may be headed. Without reforms, debt held by the public is projected to rise from 98 percent of GDP today to 195 percent by 2050. If Congress expands programs or the nation gets hit with new crises, debt will rise even faster. Americans in the future will face their own costly health, military, and other challenges, and they will have to bear those new costs plus the costs of our excess spending imposed on them through debt.

In its usual understated way, the CBO summarizes the threat:

High and rising federal debt makes the economy more vulnerable to rising interest rates and, depending on how that debt is financed, rising inflation. The growing debt burden also raises borrowing costs, slowing the growth of the economy and national income, and it increases the risk of a fiscal crisis or a gradual decline in the value of Treasury securities.

Here are some charts from the CBO study:

The first chart shows that federal debt spiked in the past from wars and other crises, and that debt will soar to record levels in the future even under CBO’s smooth‐​sailing economic projections.

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Washington has a spending problem, not a revenue problem. The next chart shows that, without law changes, tax revenues will remain a fairly stable share of the economy, while spending rises rapidly because large federal programs are on an auto‐​pilot growth path.

CBO spending and revenue projections

This next chart shows the growth of federal spending categories under CBO assumptions. The downward slope of the “discretionary” and “other mandatory” lines may be optimistic because Congress occasionally spikes spending on those categories and each of the programs within the categories have lobby groups pushing for more.

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Tax revenues are expected to edge upward in coming years even without legislated increases. The next chart shows that real bracket creep and expiring tax breaks will boost the federal tax share of the economy.

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The last chart shows the largest cost driver in the federal budget—health care. One of the presidential candidates plans to expand government health care, yet both parties have failed to tackle the ballooning costs of the health programs we already have.

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How should we tackle the budget crisis? Downsizing Government proposes many spending cuts.

September 23, 2020 12:03PM

Is Disaster Aid Political?

By E. Frank Stephenson and Peter Van Doren

In the summer issue of Regulation, Steve Horwitz and E. Frank Stephenson published an article summarizing research on the long history of political considerations in the allocation of disaster relief. Several papers document New Deal era aid being steered to swing states; a similar pattern has been found more recently for presidential disaster declarations.

Two recent articles suggest the mixing of politics and disaster aid by the Trump administration. The New York Times, reports that the Government Accountability Office found that the Trump administration has directed a disproportionate amount of farm aid to Southern states, including Georgia, the home of Agriculture Secretary Sonny Perdue. The GAO report examined $14.5 billion of payments made in 2019 to offset China’s backlash against American farm products following President Trump’s imposition of tariffs on Chinese‐​produced goods. GAO found that Georgia farmers received $42,545, more than double the national average of $16,507, and suggested that part of the disparity arose from more generous payment rates for crops grown in the South relative to other parts of the country. It’s worth noting that Republicans disputed the findings and focusing aid on Southern states instead of contested states such as Iowa, Minnesota, and Ohio might not be the smartest strategy for the GOP.

The Washington Post reports on the sudden reversal of President Trump about disaster aid for Puerto Rico, which has been struggling to recover from 2017’s Hurricane Maria. President Trump, who had been parsimonious with federal aid for Puerto Rico, announced that FEMA would provide more than $11 billion of aid to rebuild schools and the electrical grid on the island. Puerto Rico has no electoral votes, but Florida is a swing state with a sizable Puerto Rican population and media reports suggest that Trump’s aid package is an attempt to curry favor with these voters.

We cannot be sure if the agricultural aid or disaster relief are motivated by politics. But if the news reports are accurate, the public should not be surprised because politicized disaster relief is politics as usual.

September 21, 2020 5:14PM

Federal Spending Hits $6.6 Trillion

The Congressional Budget Office has released new estimates. Federal government spending jumped from $4.5 trillion in fiscal 2019 to $6.6 trillion in fiscal 2020, as shown in the chart below. That huge increase was financed by borrowing, the costs of which will land on taxpayers down the road.

The federal government has grown from a weak shell that struggled to raise cash for the Revolutionary War to today’s powerful machine able to quickly summon an extra $2.1 trillion seemingly out of thin air. Of that, $1.8 trillion was from legislation responding to the health crisis and recession (Table A-2). That is more than $5,400 per person in the nation.

CBO projects baseline outlays in fiscal 2021 to be $5.1 trillion, which includes $307 billion still flowing through the pipes from relief bills already passed.

Policymakers are considering additional relief spending. The House passed a bill in May to spend $3.1 trillion more, but Democratic leaders now say they will accept $2 trillion. If that extra aid passed, fiscal 2021 spending could hit $7.1 trillion, as shown in the chart. However, some of the additional spending would likely slop over into later fiscal years.

Senate Republicans recently supported $300 billion more in relief, which would increase 2021 spending to $5.4 trillion. President Trump said that he favored “something like” $1.5 trillion more, which would increase 2021 spending to $6.6 trillion. If regular 2021 spending is above the CBO baseline, these spending totals would be even higher.

Sadly then, the only options on the table for federal spending are like Starbucks sizes Grande, Venti, and Trenta. If you think those pricey coffees empty your wallet, you ain’t seen nothing yet.

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September 17, 2020 4:29PM

Federal Reserve Aid to State and Local Governments

I testified today to the Congressional Oversight Commission regarding federal and Federal Reserve aid to state and local governments. The commission was set up to examine a $500 billion pot of money set aside by Congress to aid businesses and the states during the crisis.

I made two general points:

First, with the economy rebounding, state and local tax revenues likely won’t fall as much as previously thought. Indeed, state and local revenue losses continue to be overestimated by most commentators. Further aid from Congress or the Fed is not needed.

Second, the Fed’s program of direct lending to state and local governments undermines market discipline and risks politicizing the Fed. There is no market failure here that needs federal intervention. State and local governments can and should borrow from regular credit markets.

My testimony starts at about 1:30 on the video. My views and analysis were in sharp contrast to the other four panelists, so I appreciate Senator Toomey for the invite and his openness to hearing a contrasting perspective.

s
September 10, 2020 5:18PM

State Policy Favoritism and Corruption

California leaders are in the news for passing a misguided law that requires most independent contractors to be treated as employees, and then realizing how harmful that is and passing another law exempting dozens of politically important industries from the mandate. Lee Ohanian describes the law’s damage here.

Last year, “Assembly Bill 5 included exemptions for many politically‐​connected occupations like real estate agents and doctors, but ensnared many others, drawing particular criticism from musicians, independent truck drivers, franchise business owners and freelance writers.” Then in response to the public backlash, the California legislature passed Assembly Bill 2257, which exempts “many occupations in media, music and other industries from AB 5’s requirements.

Unneeded laws, such as this, that impose unequal justice generate endless lobbying, litigation, campaign contributions, and corruption as companies and labor unions jockey for special treatment from politicians.

State tax policy is rife with similar favoritism. Politicians impose ill‐​conceived and damaging taxes that induce affected businesses to howl in protest and lobby for relief, and then the politicians pass an array of “exemptions,” “incentives,” “abatements,” and “credits” for the lucky few. Politicians also use state tax codes to flex their central‐​planning impulses, passing breaks for sexy and high‐​profile industries such as solar power, data centers, and filmmaking.

In reviewing state budgets for Cato’s upcoming Fiscal Report Card on America’s Governors, I came across a 30‐​page summary of tax favoritism in the State of Nevada’s budget, which starts on pdf page 18 here. Starbucks received special grants from the state’s Catalyst Fund, which “incentivizes the expansion or relocation of businesses that will quickly result in the creation of high‐​quality, primary jobs in Nevada.”

Here is my interpretation of the various breaks:

  • Nevada mistakenly imposes sales tax on capital goods (rather than just on final consumption), and then it provides two‐​year abatements for chosen firms. Why two years? Perhaps to maximize campaign contributions and support from business lobbyists.
  • Nevada imposes a “Modified Business Tax” and then provides breaks to companies that jump through political hoops on hiring and expansion. The MBT lands on a portion of business payroll. Why not just impose a simpler across‐​the‐​board flat tax explicitly on employee wages? Because politicians want to create the illusion that businesses are paying for the cost of government, not workers.
  • Nevada’s local governments impose property tax on “business personal property,” such as machinery and equipment. That damages investment, so the state provides “abatements” to certain favored companies. But states should not impose property tax on business equipment at all, just as they do not impose it on washing machines and fridges in homes. Property tax should apply evenly to residential and business real property. Why do states impose property tax on business equipment? To hide tax burdens from the view of voters.
  • Nevada politicians act as central planners in providing complex sales and property tax breaks to favored activities such as recycling, aviation, data centers, workforce innovations, renewable energy, green buildings, and film productions such as the erotic thriller “Frank and Lola.” The state also provides abatements to large companies with more than $1 billion in investments, thus favoring them over small companies.

Nevada’s complex system of tax favoritism is misguided. State policymakers should apply property tax at a single flat rate to residential, commercial, and industrial real property, but not business personal property (machinery and equipment). They should repeal special business taxes (including the “Commerce Tax” and “Modified Business Tax”), which hide government tax burdens from voters. Finally, policymakers should impose Nevada’s general sales tax at a single rate on final consumption, not on intermediate goods and capital equipment.

Policymakers in every state should impose taxes that are simple, visible, equal, and neutral across economic activities. To grow, states do not need “economic development” bureaucracies such as Nevada’s that hand out narrow breaks, they just need lean governments and low, flat tax systems.

s
September 9, 2020 3:13PM

Senate Is Right to Resist State Aid

Another week, another news story about supposedly imploding state‐​local government budgets. A New York Times headline warns, “With Washington Deadlocked on Aid, States Face Dire Fiscal Crises.”

The story leads with, “Alaska chopped resources for public broadcasting. New York City gutted a nascent composting program that could have kept tons of food waste out of landfills. New Jersey postponed property‐​tax relief payments.” The piece is built around such anecdotes, which do not seem dire to me.

Senate Republicans are right to resist the additional state bailouts pushed by House Democrats because the states can and should handle their own budget challenges going forward.

The NYT discussion conflates the situations of state and local governments. While state income and sales tax revenues have dipped, local governments raise 72 percent of their tax dollars from property taxes, which are rising. Property tax revenues were up one percent in the second quarter of 2020 from the first quarter.

The estimate of overall state budget gaps mentioned by the NYT is from Moody’s, but that is a high‐​end number. Tax Foundation summarizes three lower estimates here.

The CBO released new federal revenue projections last week, which may be suggestive of possible state revenue reductions. Just considering the effects of the recession, CBO projects that fiscal 2020 tax revenues will fall a modest 6.4 percent from 2019. GDP is expected to fall just 2.7 percent in fiscal 2020 before starting to rise again. (CBO separately calculates the revenue losses from tax cuts in recent relief bills).

If state tax revenues dropped the same 6.4 percent in calendar 2020, that would be a modest $70 billion reduction from calendar 2019 state tax revenues of $1.09 trillion. Local tax revenues nationwide may not fall at all, as they did not fall in the last recession.

Regular federal aid pays for more than one‐​quarter of overall state revenues, so a 6.4 percent drop in state tax revenues translates into a smaller percentage drop in overall state revenues. And that is true before recent federal relief bills, which have showered more aid on the states than they have lost in tax revenues. The chart below (based on Table 3.3) shows the small dip in state‐​local tax revenues in the second quarter of 2020 compared to the large increase in federal aid.

The states face budget challenges, but the situation in most places is not “dire.” State officials can solve budget gaps without further federal aid by tapping rainy day funds, freezing hiring and wages, and improving program efficiencies.

More on this topic here, here, here, and here.

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Note: In the chart, I’ve included “capital transfer receipts” in the aid‐​to‐​states total.

September 4, 2020 3:27PM

Federal Aid Creates Central‐​Planning Power

The Trump administration is threatening to cut federal aid to cities that do not follow its approach to policing and civil unrest. The administration also wants to cut aid to public schools that do not follow its approach to reopening. Previously, the Obama administration tried to micromanage neighborhoods and housing through control over federal aid dollars.

As a general matter, there is no reason to think that federal politicians have superior knowledge to state-local leaders regarding how to run policing, schools, housing, and other local activities. Unfortunately, having power over an armada of 1,386 aid-to-state programs makes federal politicians think they are national central planners. Trump, Obama, and other presidents exude self-confidence, but they do not know how to run the affairs of 50 states and 19,000 cities and towns across our huge nation.

This study argues that Congress should repeal all federal aid-to-state programs for many reasons, including that aid comes with costly strings attached that destroy local democracy. Richard Epstein and Mario Loyola noted about aid programs: “When Americans vote in state and local elections, they think they are voting on state and local policies. But often they are just deciding which local officials get to implement the dictates of distant and insulated federal bureaucrats, whom even Congress can’t control.”

I came across a table (p. 82) in New Jersey’s budget that lists the $15 billion the state received in 2020 from each of almost 400 federal aid programs. The data reproduced below illustrates the vast reach of the federal government’s tentacles.

One of the line items includes $10,000 for circus training in Camden. Is there anything that the federal government doesn’t subsidize?

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