It wasn’t exactly So You Think You Can Dance, but watching Congress and President Bush boogie their way through the final song of the recent Medicare prom was still a hoot.

 

In the end, Hill Democrats stomped Bush and, despite his veto, easily passed a Medicare bill that delayed, yet again, mandated cuts in physician payments. The Dems did so while insisting they were for both true competition and fiscal responsibility. Bush, trying to claim those same virtues for himself, had unsuccessfully tried to block the bill, insisting it would hurt beneficiaries by curbing their access to managed care plans.

 

Even by Washington standards, Bush wins a chutzpah award for attempting to justify a 13 percent subsidy to private managed care companies in the name of market competition. Medicare managed care, done properly, might improve patient outcomes and save money. But we have never seen it done right, despite at least three tries over the past two decades, in part because insurers built their business models around these unsustainable subsidies, then cut and ran when the largess dried up.

 

Congress shares the chutzpah award, however, for trying to wrap itself in the cloak of free markets while trashing efforts to require competitive bidding for both private lab services and durable medical equipment such as wheelchairs. When it comes to slashing subsidies for insurance companies, Congress loves markets. When it comes to ending high-cost sweetheart deals for a handful of equipment companies, not so much.

 

Then, there is the doctor fix, which set off this whole hullaballoo. Last century, Medpac, an independent body that advises Congress on Medicare, recommended that physician reimbursement rates be trimmed. Each year or so, Congress dutifully bows to pressure from the doctor lobby and effectively freezes, rather than cuts, physician payments. This year, the reduction was supposed to be 10.6 percent, mostly because prior cuts had been repeatedly put off. When this comes up again in 2010, the docs will be in line for a 20 percent cut in payments. Care to guess how that will come out?

 

This fracas shows just how hard it is to do anything to control Medicare costs. These ballooning expenses are the biggest single risk to the nation’s  long-term fiscal sustainability and, thus, a critical driver of tax policy over the next decades. Yet, Washington is not willing to reduce payments, or even encourage a tiny bit of price competition, for providers. And it took a huge battle to trim subsidies for Medicare managed care, which has become a honey pot for private insurers, especially the four companies that dominate the market.

 

And remember, all of this blood was spilled over payments to docs, equipment suppliers, and insurance companies, not patients. Just imagine what will happen when Washington tries, as it inevitably must, to tell seniors that Medicare will no longer pay for tests and treatments they want but which have no proven medical benefits. That, I promise you, will be no dance contest.  

 

I turned in my PhD dissertation just in time. I can’t believe I’m going to be a doctor of public finance.

My paper: An Alternative Tax System in the McCain Administration. It is a detailed description and macroeconomic analysis of John McCain’s plan to give taxpayers a choice of paying under the current system or through a much simpler and more efficient option.

My thesis committee of 300 economists has been hugely supportive and wrote an incredible letter of recommendation. They could not have been more effusive (for economists, at least), telling everyone how they “enthusiastically support” my analysis and how it “builds on the core principles that made America great.”

Now, I admit, I’ve been a bit distracted over the past few months, trying to get this new job and all. So my paper is not as complete as it might have been. Well, actually, I never did say what income I would tax. And I never got around to proposing a rate structure either. So, I couldn’t say what the distributional impact would be, or what the new plan would do to federal revenues. And, I had to skip the section on what it would mean for economic growth. I’m sure you understand: Without the rates or the base, the macro analysis just didn’t hold together. But trust me, the optional new tax will be way better than the current Internal Revenue Code and won’t even increase the deficit.

Who cares about all these boring details, anyway? My thesis committee includes former senior government economists and professors at our best universities. And they didn’t need specifics, so why should you? Even though they had no idea what McCain is proposing, this is what their letter said:

"His plan would also create a new and much simpler tax system and give Americans a free choice of whether to pay taxes under that simple system or the current complex and burdensome income tax."

There are a few spoilsports. Always are. For instance, the grumps at the Tax Policy Center keep looking at the versions proposed by former GOP presidential hopeful Fred Thompson and the Republican Study Committee. They would create an optional tax with rates of 10% and 25%, with a standard deduction of $25,000 for joint filers. TPC figured Thompson’s plan would add $7.6 trillion to the deficit over 10 years. I know that sounds like a lot of money, but it isn’t my plan. I promise.

I’ll get you those details soon. After all, my defense isn’t scheduled until Nov. 4.

John Endean raised an intriguing idea the other day in response to my blog on whether business executives would be willing to give up targeted tax breaks in return for a lower corporate rate, as John McCain has suggested.

John, who is president of the American Business Conference, said that one of his CEO members has a different swap in mind: Completely repeal the “terrible” corporate income tax and pay for it by raising rates on top-bracket taxpayers. In effect, this would directly tax the owners of capital rather than doing so through the backdoor of the corporate tax.

John wrote:

What to do about the lost revenues if that happy day ever comes? One CEO in my association recommends "paying" for abolition by raising the marginal tax rates on the income of wealthy taxpayers. This approach at least has the advantage of reminding everyone that the corporate tax is paid by people even if incidence theory suggests that the tax falls on poorer, rather than richer, Americans.

Well, I asked TPC’s Jeff Rohaly to run this idea through the Big Computer to see what would happen. The results were fascinating. It turns out that if you want to finance complete repeal of the corporate tax, you’d need to boost the top three individual rates to an eye-popping 50.1 percent, 59.1 percent, and 62.7 percent, and raise the tax on capital gains and dividends to about 27 percent. If you leave the rates on gains and dividends untouched, taxes on ordinary income would have to double to 56 percent, 66 percent and 70 percent.

This is a rough and ready static analysis, so it doesn’t take into account changes in taxpayer behavior. In reality, it would probably drive rates even higher since such a shift would create huge opportunities to shelter income.

The problem is that even though the corporate tax is hugely inefficient and riddled with loopholes, it still will take in about $360 billion this year. Making up that kind of money is not easy, it turns out.

Economists disagree over how much corporate tax ends up being paid by owners of capital and how much is paid by workers, but, as John suggests, it is not a bad idea to try to find a way to make this tax explicit.

A better choice would be to fully integrate the corporate and individual tax so all profits are taxed just once. Many broad reform plans try to tackle this and the idea does not seem that far from what John's CEO likes.

Unfortunately, simply repealing the corporate tax and dumping the cost on high-income taxpayers would induce both serious sticker-shock and egregious sheltering. Something to keep in mind the next time someone breezily suggests repealing the corporate tax.

My blog on “How the Budget Baseline Favors Spending” stimulated numerous thoughtful comments. Some implied that my proposal would reward those who wish to make the Bush tax cuts permanent and ignore the fact that dubious accounting was used to get them passed in the first place. Those arguing this point did not pay sufficient attention to my last paragraph which implied that baseline reform would have to await the disposition of the Bush cuts. Further, I alluded to the possibility that whatever portions of the Bush policy are extended, the extension will again be temporary, thus making it difficult to finally settle the point.

The most challenging point was raised by Blue Dog. It was argued that if the baseline assumes that temporary tax cuts are permanent, should they not also be scored using the same assumption? I think that follows logically. The problem is that there are tax cuts that are clearly meant to be temporary and probably will be. The tax cuts in the recent stimulus package are an example.

There are two possible solutions to this problem. One approach would deal with it by attempting to differentiate tax cuts that were clearly meant to be sunset from those really intended to be permanent. Blue Dog noted that we do that with entitlements, but there are obvious difficulties and the necessary language would complicate a budget process that has already become so complex that only a few people in the world understand it all. (I am not one of them.)

The other approach would be to ignore the problem. The budget process contains many illogical features, and perhaps, we should accept one more. Currently, there is no attempt to differentiate appropriations that are almost as permanent as entitlements, e.g. financing the Bureau of Labor Statistics, from those that we fervently hope will be shorter lasting, e.g. funding the wars in Iraq and Afghanistan. Since almost all of the many temporary tax cuts are meant to be permanent, it may not be too inaccurate to regard all as permanent, even those few that are clearly temporary. The downside of this approach is obvious. Legislators would not get any reward for making certain tax cuts truly temporary when that is the fiscally responsible thing to do.

Moreover, ignoring the problem raises another issue. The Byrd rule does not allow reconciliation procedures to be used for legislation that increases the deficit beyond the budget horizon. This provides a very strong incentive to claim that all tax cuts and entitlement increases are temporary. Scoring them as permanent would have ruled out the stimulus package, although it must also be remembered that rules can be waived and points of order defeated. Many have argued that in any case, reconciliation should not be allowed for any deficit increasing measure and that would solve this problem. The counterargument is that it is so easy to block policy changes in the Senate that it is necessary to keep the option of using reconciliation for both deficit increasing and reducing policies.

This discussion shows how incredibly complicated the budget process has become. The needed debate about reforming the baseline probably has to be extended to reforming the whole thing.

Unlike many bloggers, I am not going to bash John McCain’s renewed interest in balancing the budget. It is nice to see his on-and-off love affair with fiscal responsibility heating up again.

There is just one problem with his vow to balance the budget by 2013. He can’t do it. Or, to be more precise, he can’t do it while extending the Bush tax cuts, cutting other taxes of his own, and maintaining a costly military presence in Iraq.

The numbers not only don’t add up, they don’t even come close. To see why, take a look at some rough estimates. CBO figures Washington is on track to spend about $3.5 trillion in 2013 (assuming zero spending for Iraq) and to collect roughly $3.6 trillion in revenues (assuming the Bush tax cuts expire in 2010). To put it another way, Washington will spend about 19.5 percent of GDP and raise about 19.9 percent, which would produce a modest surplus.

But, of course, McCain wants to cut taxes—a lot. TPC estimates he’d slash revenues by almost $400 billion in 2013 alone. As a result, McCain would collect only about $3.2 trillion in taxes, or roughly 17.8 percent of GDP. With no changes in spending, that would leave him about $300 billion, or 1.7 percent of GDP, short. Plus, he’s likely to need extra cash to pay for continuing operations in Iraq. So where would he find the dough?

McCain's new economic plan includes only a few specifics. He’d freeze non-defense discretionary spending for a year. That sounds dramatic, but since most government spending is for Medicare, Medicaid, Social Security, the Pentagon, and interest on the debt, I figure it would trim spending by only about $20 billion. He also pledges to eliminate pork. Nobody knows exactly what he means, but he might find another $20 billion.

All this gets him less than 15% of the way there. Where will the rest come from?

There is only one place, and that is the black box in the McCain plan: Entitlements. He says he wants to reform Medicare, Medicaid, and Social Security. He also vows to restrain annual increases in all government spending to 2.4%, just a bit more than half the pace CBO projects for the next decade. That kind of slow-down is simply not possible without big changes in the Big Three.

Could McCain come up with a sensible plan to fix Social Security? Sure. Would it yield much money by 2013? Nope. One reason: Any plan would be phased in over decades to protect current and soon-to-be retirees. Could he slow Medicare growth by 2013? I don't see how, especially since so much of the problem can be traced to overall health spending which seems intractable.

I’m glad that McCain is at least talking about balancing the budget again. But he still hasn’t even come close to telling us how he’d do it.

The Wall Street Journal editorial page ran one of its favorite tables the other day, purporting to show how uncompetitive the U.S. corporate tax regime is with the rest of the developed world. The chart shows that, at nearly 40%, combined state and federal statutory rates here are far higher than the average of the countries in the OECD.    more »

The Congressional Budget Office’s expenditure and revenue baseline is supposed to illustrate the budget implications of extending current policy. Few may care how the baseline is actually constructed, but since all policy changes are measured “from the baseline,” the arcane definitions that describe current policy can have a profound effect on Congressional decisions.    more »

Lots of buzz lately about sovereign wealth funds—those huge investment pools run by foreign governments that are becoming an increasingly important source of capital for U.S. companies. The Wall Street Journal’s Michael Phillips reports that foreign investors bought nearly $1 trillion in U.S. securities in 2007. And a small but growing share was acquired by sovereign wealth funds operated by dozens of countries, including China and the oil-soaked nations of the Middle East.    more »

Less than an hour after Howard Gleckman posted a blog entry on the presidential candidates’ tax plans, a question came in about TPC’s finding that Senator Obama’s plan would increase taxes of a low-income elderly couple by $150. How, the commenter asked, could that happen if Obama said he’d eliminate taxes for elderly households with income under $50,000?    more »

Barack Obama has a plan to fix Social Security. Or does he? Obama does have a vague proposal to raise payroll taxes for workers making more than $250,000. But there is a lot less to it than meets the eye, and Obama has left some hugely important questions unanswered.    more »

I'll be moderating what should be an interesting discussion on fundamental tax reform at the New America Foundation on Tuesday. Other panelists will be New America's Maya MacGuineas and Michael Lind, and Yale University's Mike Graetz, who has designed a new Value Added Tax. If you’d like to join us, sign up at NAF's website.

How will ordinary families be affected by the tax plans of John McCain and Barack Obama? To get some answers, I asked Greg Leiserson, TPC’s crack modeler, to develop some examples.

The results mostly track what we already know—that McCain would cut taxes somewhat for nearly all, and a lot for the very wealthy, and Obama would cut taxes substantially for low- and moderate-income families and raise them dramatically for those in the upper brackets. But there are also some surprises.

Before I look at how the tax cuts would work for some typical families, keep in mind that TPC allocates a share of any changes in corporate taxes to individuals. Thus, their tax liability not only includes what happens to their income taxes, but also to their share of corporate taxes. Economists do this since companies don’t actually pay tax, the people who own the companies do. (Workers pay some share too, but since no one can agree on how much, TPC allocates all the tax to capital).

With that out of the way, here is what the numbers look like:

A single mom, with one child, making $15,000-a-year (in adjusted gross income) would get a $17 tax cut from the McCain plan, but see a $500 reduction from Obama, thanks to his new work credit.

A newly-married young couple with no kids, making a combined income of $50,000, would get a $36 tax cut from McCain, but a tax reduction of about $1000 from Obama. The big difference again: Obama’s work credit.

By contrast, think about the classic suburban 1950s sitcom family, with two kids but only one wage earner, who makes $75,000. Ward and June Cleaver would do a bit better under McCain, who would cut their taxes by $800, while Obama would trim their taxes by only about $500. McCain’s increased dependent exemption for Wally and the Beave trumps Obama’s work credit.

Now, let’s look at a two-lawyer family, making $200,000, with one child. McCain would give them a tax cut of roughly $7000, while Obama would trim their taxes by about $5000. The big reason: each candidate would patch the Alternative Minimum Tax.

A married baseball player who takes home $2 million and has one child might want to go to bat for McCain, who would give him a tax cut of more than $30,000. Obama would raise his taxes by $135,000. Talk about getting one in the ear.

For seniors, the pattern is a bit more surprising, since Obama has been touting his tax cuts for the elderly. Obama would give an unmarried senior making $35,000 a tax cut of $3000, which would wipe out her tax bill. McCain would give her a tax cut of about $250.

But now let’s look at that her neighbor, who makes $75,000 from her Social Security, pension, and other income. Obama would actually raise her taxes by about $600, while McCain would give her a $600 tax cut. 

The same thing would happen to a very poor elderly couple making just $10,000. Obama would raise their taxes by $150, while McCain would cut them by about $170.

Of course, these are all averages. Some families might benefit more and others less. But this should give you a pretty good idea of the winners and losers.

Johnny, we hardly new ye.

John McCain’s ambitious plan to reform corporate taxes is disappearing faster than the Washington National's chances to win the national league pennant. What once had the makings of a provocative and potentially beneficial idea is morphing into a gimmicky mess.

Earlier his spring, McCain was talking about allowing companies to expense all their capital investments in the year they are made. This would eliminate many of the timing-related issues that make corporate taxes so complicated. It might even have become the first step towards replacing the income tax with a cash-flow levy. In such a system—a version of a Value Added Tax—companies would subtract their costs of goods from revenues and pay tax on the difference.

Back then, McCain had not yet answered one big question: What would happen to the tax deduction companies take for their interest payments? In any sensible expensing scheme, interest could no longer be tax deductible. If it were, businesses would become huge tax shelters.

Now that he’s started to answer this and other questions, his idea is getting worse. In his revised plan, which staffers have described to TPC, expensing would be limited only to short-lived property—equipment like cars and computers--now depreciated over five years or less. The proposal would be temporary, and would expire after five years. Interest payments would be taxable, but only if used to finance specific short-lived investments.

Yuck. Speeding up a deduction that you could take in a couple of years anyway is not much of a tax break. Making the proposal temporary just creates messy new timing issues—and would threaten to become yet another tax “extender” that is part of the annual Washington theater. And tying the interest deduction to the purchase of specific property will surely create endless opportunities to game the system. This will bring joy to the hearts of investment bankers and tax lawyers, but not to the rest of us.

The best that can be said about McCain's latest version is that perhaps it is an effort to shove the tip of the camel’s nose under the proverbial tent: Start with this and get more ambitious later. But that's a reach. Don’t get me wrong, McCain’s initial proposal had its problems, but it was intriguing, potentially far-reaching, and worthy of debate in a presidential campaign. This version will fall into the dust-heap of forgotten ideas. There was a brief moment when I thought we were going to have a serious tax reform debate in this campaign. I should have known better.

Barack Obama’s tax plan will either raise $262 billion over the next 10 years or increase the national debt by $2.7 trillion. John McCain would add either $615 billion or $3.6 trillion to the debt.

What’s going on? Don’t everyone turn your computer off at once, but we need to talk about budget baselines.

There is nothing more esoteric, but Obama and McCain have made them hugely important. Trillions of dollars important. In fact, the only way either candidate can establish even a nanobit of fiscal credibility is by dramatically reframing the deficit discussion.

Both want to convince us that the Bush tax cuts will go on forever, even though they are due to expire in 2010, and that the Alternative Minimum Tax mess has already been fixed, although a permanent solution is nowhere in sight. With these helpful assumptions, their trillions of dollars in tax cuts look modest. Both candidates can make it appear as if they are merely moving around a bit of loose change, rather than massively increasing their grandchildren’s debt.

This is nothing more than a fiscal parlor trick. McCain, at least, can argue that he has supported the Bush tax cuts—well, he supported them after he opposed them. Obama has voted time and again against extending them and calls them irresponsible. What is likely to be a strongly Democratic Congress will never vote to sustain them as is. Yet, both Obama and McCain would like us to believe these tax cuts are cast in stone—the fiscal Ten Commandments, if you will—even as they propose to change them.

Neither seems to have noticed that Washington routinely overhauls the tax law every decade or so. When it comes to taxes, change is the status quo.

There is an easy way to cut through this palaver. Forget the baseline. Just think about three numbers: How much would either candidate collect in taxes as a share of the Gross Domestic Product? How much is government likely to spend? And, how much would they have to cut that spending to keep the national debt from ballooning.

TPC estimates that in 2013, Obama would collect revenues of 18.2 percent of GDP. McCain would bring in about 17.8 percent. Spending that year would be about 19.5 percent, according to the Congressional Budget Office, assuming the Iraq war will be winding down.

Thus, Obama would have to cut spending by 1.3% of GDP or $230 billion, to balance the budget in 2013. McCain must find 1.7% of GDP, roughly $300 billion. For context, Bush and the Congress have been battling for years over budget cuts one-tenth that size.

I await word on the candidates’ additional spending cuts. Obama has embraced costly new initiatives for infrastructure, education, health care, and energy, but said little about exactly where he’d cut spending. McCain vows to cut pork, which might get him 5% of what he needs. On the other hand, he is not likely to end the war any time soon.

We have updated our preliminary estimates of the revenue effects of the candidates’ tax plans. Our estimate for the ten-year revenue change compared with current law from Senator Obama’s plan is identical to that in our original study—a $2.7 trillion revenue loss. Our updated projection for Senator McCain’s plan shows a revenue loss of $3.6 trillion instead of $3.7 trillion. With interest costs, Obama would add $3.3 trillion to the national debt, while McCain would increase the debt by $4.3 trillion.

Our new estimates also show that if current policy is extended beyond 2010—the way both candidates prefer to describe their plans—Obama would raise $262 billion in tax revenues and Senator McCain’s would reduce revenues by $615 billion. Our initial estimates understated the revenue loss for McCain and overstated the revenue gain for Obama against this baseline. We also made minor revisions to some other estimates.

Note that our estimates for the candidates’ plans reflect some of the ways people change their behavior when tax laws change. For example, some people can be expected to switch from taxable to tax-exempt bonds when rates increase. In the past, we estimated only the static effect of tax changes. Static scoring had the virtue of simplicity—most estimates came straight from our tax model—but the disadvantage that they were not strictly comparable with official revenue estimates, which do account for behavioral responses. We plan to reexamine our assumptions and methodology before we release the next update of our paper on the candidates’ tax plans. We also expect the next version to include an analysis of both candidates’ health proposals and more analysis of proposals we left out of our original version: Obama’s stated plan to increase Social Security taxes on those earning over $250,000 and McCain’s proposal to allow taxpayers to elect a simplified alternative tax system.