Sunday, February 28, 2010

FBB Part 2: Taxes

Part 2 of the 'Bank Slate Federal Budget Blueprint series. The goal of this series is to make realistic recommendations that would allow the US to balance in the budget within 10 years. The basic tenants of the the 'Bank Slate Federal Budget Blueprint are:
  • The year 2000 should be used as a policy baseline. Tax and spending policies should be reset to the levels and rates they had in 2000.
  • Any policies enacted since 2000, that we wish to keep, need to be funded.

Politicians and the good citizens they represent always think taxes should be lower. If times are bad, or maybe they aren't so bad, but we want them to be better-- we can stimulate the economy by cutting taxes. And if times are good and there's a budget surplus-- well then that's not the government's money. That's your money! You should get it back.

For Republicans there is no problem that can't be solved by cutting taxes. Even today they all promise to "cut taxes and reduce the deficit". There is no political cost to uttering this nonsense.

Even the Democrats have gotten in on the act. Clinton and Obama both realized that calls for spending increases will be met with protest. But everyone likes a targeted "tax credit". These are much easier to pass even if the result is pretty much the same.

 Nobody like taxes. I don't like taxes. I don't like paying my credit card bills either. But if you're going to spend the money you've got to get it from somewhere. Somewhere means income or debt. Conservatives say they don't like the government spending all this money. But their commitment to tax cuts is not matched by a commitment to spending cuts.

After a decade of tax cuts for all seasons, we're looking at a $1.56 trillion 1 year budget deficit. There is no party willing to enact tax hikes. And there are no Americans who are going to demand it.

Fortunately, there is a simple solution. In fact, it's the simplest of all possible solutions. Congress should do nothing at all.

In their wisdom, the Bush Administration and its congressional supporters, scheduled all of the Bust tax cuts to expire this year. At the end of 2010 all the Bush tax cuts -- income, capital gains, estate etc.. are scheduled to reset to their 2000 level. Obama's tax cuts are also scheduled to expire in a year or two. Obama has suggested that congress should extend some of the tax cuts that go to "working families". Congress should not do this. The projected deficit is $1.56 trillion. We can't afford the tax cuts. Not even the ones that go to me.

The other tax that congress should to nothing about is the AMT. The AMT (Alternative Minimum Tax) was enacted in 1969 and designed to make sure Americans with high incomes couldn't hide all of it in tax shelters. The problem with the AMT is that it didn't account for wage growth over time. What was considered "high income" in 1969 counts is considered to be "middle-class" today-- although we still mostly talking about couples with income over $200k.

Every few years congress "fixes" the AMT by bumping up the level where it goes into effect. But the AMT is a simple, progressive tax system. So, we should leave it alone, even if I end up paying it some day.

Raising taxes is always a bitter pill to swallow. But reverting to year 2000 tax policy will be much less nasty than ongoing $1.56 trillion dollar deficits. And all congress has to do is nothing at all.


  1. Simple it is not. As the linked article suggests, it may be simple when you elect not to itemize deductions, which is not very common if you are a homeowner, for example. Moreover, the problem is that it is very difficult to predict when, say, you are looking to buy a house, what portion of your mortgage interest will be deducted -- and it will change depending on your income. So, the effect of inflation makes home ownership more expensive each year for more and more people at lower and lower income levels when inflation is considered, so that you might be unexpectedly paying more for your house in year 10 or 20 than you were in year 1. Anyway, it is not a terribly bad problem to have to pay some amount of AMT now, which we have done for a couple of years, but it can disturb settled expectations when you try to plan ahead by the rules. A universal flat tax without the deductions (i.e., social engineering), would be better than the AMT without inflation adjustment. It doesn't really matter at what level the AMT bar is set, as long as it is inflation-adjusted. So, for example, set it at 200K (or 100K or whatever is necessary/fair), but we SHOULD adjust for inflation to allow for people to plan ahead to a reasonable degree.

  2. The AMT itself is fairly simple. The problem is you always have to calculate it on top of doing your taxes the normal way (which is not so simple).

    Generally, I agree that creating tax policy with fixed numbers that don't adjust for inflation is pretty dumb. But recently the Fed. Govt. has been pretty good about managing inflation. And they've been really bad at balancing the budget. Given the political and public reluctance to increase taxes, if your serious about reducing the deficit, the short-term risk of congressional tinkering is worse than the risk of a little AMT neglect.