Politics & Policy

The Math Problem That Could Sink the Bernie/AOC Agenda

(Pixabay)
Their policies will need dramatic reform to pass muster with the CBO and JCT, and they’ve not shown the willingness to compromise such reform will require.

Editor’s Note: This piece first appeared on the Manhattan Institute’s E21 blog. It is reprinted here with permission.

The greatest constraint on the objectives of democratic socialists in Congress, such as Representative Alexandria Ocasio-Cortez and Senator Bernie Sanders, may not be Republicans or even centrist Democrats, but rather two government institutions, the Joint Committee on Taxation (JCT) and the Congressional Budget Office (CBO). JCT and CBO have developed sophisticated models of the U.S. economy and federal budget, and they use those models to help Congress understand the impact of its legislative proposals.

Ocasio-Cortez and Sanders have championed several policies that would greatly expand federal spending, such as implementing a single-payer health-care system and radically expanding the scope of environmental regulations. According to an Urban Institute analysis, the health-care plan alone would raise federal expenditures by $32 trillion over ten years. Though the CBO and JCT have not yet analyzed such policies — they usually wait until the plans are more developed — when they do, their analyses will find that the only way to finance such large increases in federal spending is through much higher taxes, a politically unpalatable result that will surely make headlines and produce difficulties for any nascent legislation.

I worked for several years at a research group called the Tax Foundation that advised members of Congress and President Trump’s economic team during the 2017 tax-reform process. These policymakers had to be mindful of the JCT’s scores. I therefore began to learn how sensitive its model is to policy ideas — what it “likes” and “dislikes,” if you will. My experience taught me that Democrats will have a treacherous path ahead as they try to push legislation such as single-payer health care. There are four reasons why, which I outline below.

1. The Model Despises Deficits

The JCT’s and CBO’s macroeconomic models despise deficits. They operate on the same assumption about deficits, which is that federal budget deficits reduce economic growth. The theory goes like this: When the government borrows, lenders choose to lend to the government instead of to private-sector businesses. This is sometimes called a “crowd out” effect, in that government borrowing will “crowd out” funds that would otherwise have been lent to the businesses. With less money available to businesses, they invest less, and the workers are less productive.

This is a problem for those on the left, such as Ocasio-Cortez, who seeks to fund her environmental program, known as the “Green New Deal,” with debt. The standard line on the left is that a government deficit will put more money in the hands of consumers, who will spend it on goods and services. Employers will then hire more workers to satisfy that demand.

But the CBO and JCT operate on the crowd-out assumption, and it is very strong in their models. In recent publications, the CBO has shown that a policy of $500 billion in debt-financed public investment reduces GDP in the long run, In other words, the positive effects of the public investment are ultimately outweighed by the negative effects of the deficit.

2. The Model Knows Where the Money Is

The distribution of U.S. income is less skewed toward the extremely wealthy than democratic socialists imagine, and the mechanisms they propose to fund their policies will be woefully insufficient. For example, Ocasio-Cortez, in an interview on 60 Minutes, proposed a 70 percent marginal tax rate applied only to income above $10 million a year to finance her Green New Deal.

At first, this may sound like a substantial revenue-raising tax: People earning above that threshold have a lot of money, and the U.S. produces a fair number of them — over 16,000 as of 2016, according to IRS data. But this group of earners has only $245 billion of taxable income above the $10 million threshold. That comes to just over 1 percent of GDP. Most of the money in the U.S. lies elsewhere. Starting with a tax base this small limits the revenue one could possibly raise; for example, even the high rates set by Ocasio-Cortez would raise only between $164 billion and $382 billion over ten years, according to an estimate from the independent Penn Wharton Budget Model.

This is not enough for the Green New Deal, which is intended to be a multi-trillion-dollar investment. Furthermore, any tax increases intended for the Green New Deal will be unavailable for health-care reform, and vice versa. Obviously, democratic-socialist proposals will need a bigger tax base to work.

Sanders, for his part, seeks to capture a larger tax base: the vast income earned by middle- and upper-middle-class Americans. In his 2016 presidential campaign, Sanders proposed broad-based tax increases on virtually all Americans. His 2016 platform included many taxes, including a payroll tax that would affect all workers. Taxpayers in the middle quintile (40th to 60th percentile) of income, for example, would see a tax hike of 8 percent. Overall tax revenues would increase by $15.3 trillion over ten years, but even this would be insufficient to pay for his spending proposals. According to the Urban Institute, Sanders’s tax proposals would pay for only $15.3 trillion of the $33.3 trillion of spending he had proposed.

It is certainly theoretically possible to raise taxes to cover ambitious programs. But these tax increases must be distributed broadly across the U.S. population — and they must be truly enormous, so big that nobody, not even Bernie Sanders, has had the courage to propose them.

3. The Model Distributes Taxes on Institutions to Individuals

Democratic socialists might propose raising taxes on businesses or institutions instead of individuals to make their policies more politically palatable.

For example, consider the “Cadillac tax” from the Affordable Care Act. It was intended to be a 40 percent levy on expensive health-care plans, those with premiums exceeding $10,800 for individuals or $29,500 for families. The tax would be applied only to the amount by which those thresholds were exceeded, and paid by insurance companies. MIT economist Jonathan Gruber, who advised Democrats on the policy, later explained that the strategy for the tax was “mislabeling it,” by “calling it a tax on insurance plans rather than a tax on people when we all know it’s a tax on people who hold those insurance plans.”

What Gruber described is the difference between legal incidence and economic incidence. While insurance companies would write the check for the Cadillac tax, incurring the legal incidence, they would also likely raise the cost of plans eligible for the tax, passing on the tax to the insured. In effect, the insured would still end up paying the tax, just indirectly, with the insurance company acting as a middleman. Since the insured still loses money because of the tax, he incurs the economic incidence of the tax.

The economic incidence is certainly less immediately visible than legal incidence. But the JCT’s distributional analysis does not play these political games. It passes the tax increase on an institution on to the individuals who ultimately feel the burden. For example, if Ocasio-Cortez proposes raising taxes on oil companies as part of an environmental package, she would effectively be advocating for a tax on the middle class; the JCT model will show that oil companies will pass the cost along to oil consumers.

As a footnote, the Cadillac tax has still not gone into effect. Its implementation has now been delayed until 2022 in a series of bipartisan votes because of political pressure from anti-tax groups and unions. The constituency against middle- and upper-middle-class tax increases is strong, even if the incidence is only economic.

4. The Model Assumes Inconvenient Responses to Tax Increases

The JCT model suggests that people respond to tax increases in ways that will be unhelpful to Democrats. First, the model accounts for the fact that people work less and take more leisure hours when their wages are taxed more. This is known as the substitution elasticity of labor to taxation. The effect is small — typically, for every 10 percent increase in marginal tax rates, there’s a 2 percent decrease in labor supply. Lower labor supply reduces economic growth, a result that critics of the Democrats will surely note.

An even more difficult problem may be with capital-gains taxes. Specifically, Democrats might propose hiking taxes on capital gains to pay for their projects. But empirical experience and JCT models both hold that as capital-gains taxes rise, people sell stock less often, so as to defer paying the tax. Recent JCT research into the subject suggests that for every 10 percent increase in capital-gains taxes, capital gains from stock sales fall about 8 percent in the long run because of fewer sales. In many cases, especially in the short run, the increase in the tax rate is swamped entirely by this effect, meaning tax hikes on capital gains could lose revenue.

Those are just four of the problems democratic socialists must face in turning their policies into viable legislation. Many establishment Democrats respect the JCT and CBO, and will require acceptable numbers from the analyses of these two governmental groups. The only way democratic-socialist policies will pass muster with the CBO and JCT is if they’re dramatically reformed. But that will require a willingness to compromise that Ocasio-Cortez and Sanders have thus far not demonstrated.

Alan Cole — Mr. Cole is an MBA candidate at the Wharton School and a former economist at the Tax Foundation.

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