In a number of recent posts, I’ve been trying to think through the implications of the fact that President Obama seems to favor both more spending and lower taxes than the Bowles-Simpson deficit commission’s co-chairs.
One possibility is that the president will embrace a more rigorous form of health care cost containment, perhaps along the lines proposed by Ezekiel Emanuel et al. in “A Systemic Approach to Containing Health Care Spending,” an article published this April in the New England Journal of Medicine’s Sounding Board, which Bryan Dowd recently discussed in this space. Perhaps the article’s most controversial proposal is its call for the promotion of state-based “all-payer” price control systems. Austin Frakt has written a number of posts on all-payer rates and their potential pitfalls.
The other possibility, which according to Noam Scheiber’s The Escape Artists closely tracks the president’s own views and has been championed by former White House budget director Peter Orszag (as we’ve discussed a few times), is that a second Obama administration will back tax increases for households earning less than $200,000.
The prospect of tax increases on middle-income households is potentially politically explosive. The (reasonable) claim that Romney’s tax reform goals are essentially impossible to achieve without such an increase has been deployed by the Obama campaign in campaign advertisements. President Obama’s commitment, first made during his 2008 campaign, to insulate middle-income households from tax increases relative to current policy has been an extremely important political shield against anti-tax arguments. While some Romney advisors, including Glenn Hubbard, have pressed the point that the president’s spending trajectory essentially guarantees a a middle-income tax increase (specifically, Hubbard argues that it will mean an 11% tax increase), I think it is fair to say that this campaign would look very different if the Obama campaign explicitly said, like Walter Mondale’s 1984 campaign, that it fully intends to raise taxes on middle-income households.
So I found it interesting that, as Michael Linden of the Center for American Progress recently observed, the president’s endorsement of the Gang of Six deficit reduction plan hasn’t really been discussed. Linden suggests that the president gave the Gang of Six plan a “full endorsement,” and I’m not entirely sure that is true.
If it is true, however, it is worth noting the many ways in which the Gang of Six plan differed from the Bowles-Simpson co-chairs’ proposal. Keith Hennessey was particularly scathing in describing the differences in July of last year:
The fundamental trade of the Bowles-Simpson group was higher net taxation in exchange for (huge long-term spending reduction, especially in entitlements + fundamental structural entitlement reform + pro-growth tax reform).
The Gang of Six plan drops the first two elements of that trade, the huge long-term spending reductions and the structural entitlement reforms. It instead purports to offer pro-growth tax reform in exchange for much higher net tax levels. It offers trivial spending cuts, no flattening of long-term entitlement spending trends, and no structural reform to the Big 3 entitlements. That is a terrible trade, and far worse than Senators Durbin and Conrad agreed to in Bowles-Simpson. Why did the Republicans in the Gang take a deal far worse than Bowles-Simpson?
Although the Gang of Six called for eye-catchingly low marginal tax rates (according to Erik Wasson of The Hill, it called for three tax brackets that would range between “8-12 percent, 14-22 percent and 23-29 percent”), it called for a tax increase of $2.3 trillion relative to current policy — which, as Hennessey notes, was $850 billion higher than the president’s February 2011 budget proposal.
Given the cuts to marginal tax rates, could this new tax code raise $850 billion in additional revenue relative to President Obama’s favored baseline and leave households earning less than $200,000 untouched?
Before the Tax Policy Center published its (important and informative) critique of the Romney campaign’s tax proposal, it offered a broader look at the difficulties involved in cutting tax preferences to pay for marginal tax rates. Indeed, these difficulties are one reason I’m comfortable with the fact that Robert Stein’s tax reform proposal creates two ordinary income brackets of 15% and 35% and two capital income brackets of 7.5% and 17.5%. Though a top rate of, say, 29% for ordinary income and for capital income sounds attractive, it might have a deleterious impact on capital formation — a conclusion disputed by Joe Minarik and Len Burman but embraced by most advocates of consumption taxation, including Alan Viard.
I mention this because capital income taxation goes unmentioned by the Gang of Six, and it could be the vehicle through which advocates could manage the distributional impact. Hennessey suggested that a steep increase in capital income taxes was likely:
The tax reform described in the Gang’s plan is silent on capital taxation. Side conversations suggest the Gang agreed to but did not put on paper a 20% rate for capital gains and dividends. From a pro-growth perspective, lowering marginal income tax rates by raising capital taxation rates is a bad trade. And both the numbers and politics suggest that much of the higher revenues raised from “eliminating tax breaks” would come from higher tax rates on capital rather than scaling back even more popular tax preferences for homeownership, charity, and health insurance. [Emphasis added]
Like the Romney campaign, the Obama campaign has made a concerted effort to shield itself from anti-tax attacks, and I imagine the fact that President Obama was supportive of the Gang of Six proposal probably won’t be enough to make the case that he is committed to much higher taxes than he has claimed since his 2008 campaign. But the Gang of Six proposal does lend insight to where he might want to go in a second term. The short version: there is good reason to believe that the president supports really big increases in capital income taxation.
Alan Viard recently offered a smart, detailed, and nuanced take on whether or not to preserve the capital gains preference in Tax Notes, the conclusion of which reads as follows:
Although the capital gains preference does not have a clear conceptual rationale, it reduces three important distortions in the tax system: the lock-in effect, the bias against equity-financed investment by C corporations, and the penalty on savings. In each case, the preference is an imperfect solution to the problem. Nevertheless, it would be a mistake toremove the preference unless and until more sweeping reforms are adopted to address those distortions.
To Hennessey’s point, however, this is a far less politically potent argument than the case for preserving the tax preferences for homeownership, among other economically damaging distortions. This will be the challenging terrain conservatives and libertarians will be fighting on during the next tax reform debate.