Tuesday, February 12, 2008

The President's Economic Report

As you would expect from Dr. Tax - I read the President's Economic Report today - the chapter on taxes. It has some interesting stuff in it. The chapter begins with two questions that are often ignored in any discussion on taxes - how large should the tax burden be and who should pay that burden? In this chapter both are conditioned on the dead weight loss that any provision in the public sector produces. The report estimates that figure to be between 30% and 50%. That means before we finance something in the public sector it better pay off more than 30% more than it actually costs. Every tax policy distorts economic activity to some degree. We need to be wary of proposals that either increase those distortions or provide so little return that they allow some of this deadweight loss to occur. That is a pretty high threshold.

This president ran on the notion of being a compassionate conservative. For the past 40 years the share of GDP taken by the tax system has averaged 18.3% but under GWB that number went up to 18.8%. If the tax cuts are allowed to expire in 2010-11 then the percentage of GDP going to federal tax drives close to 21% by the mid point of the next decade. Those numbers are pretty high.

The chapter also discusses the growth of the Alternative Minimum Tax which started by affecting only about 20,000 taxpayers but could grow to affect 25 million. This is odd for a policy that was addressed to a small number of miscreants who somehow do not pay their fair share. The AMT was absurd on its face when it was first adopted, there are few if any people who consistently escape their fair share of tax burden. But facts then and now did not influence public policy.

Surprisingly as the Boomers begin to withdraw funds from their retirement accounts, which have been allowed to grow tax free, there will be a natural increase in the percentage of GDP going to taxes as this formerly exempt income goes back to the tax system. One way to avert the train wreck of Social Security (more on that later) is to allow tax free withdrawals in exchange for some reduction in eligibility for Social Security benefits. The combination of Medicare, Social Security and other entitlements will grow from about 10% of GDP to 20% over the next several decades - federal expenditures have rarely grown above the 20% of GDP rate so for those three categories to grow on their own could either produce a lot of deadweight loss (by increasing the level of federal expenditures well beyond where they have been in the last forty years or by cutting entitlements - neither is likely to be an acceptable solution.

Part of this chapter is a defense of a continuation of the Bush tax cuts - and indeed there is good justification for continuing many of those provisions (things like capital gains treatment were they to go back where either Obama or Clinton suggest would put us at a competitive disadvantage). A distinct impression I got from the chapter is the need to have a serious discussion about the first two questions raised in the chapter. But I suspect all but a few wonks will not be interested in those issues.

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