Yesterday, Senate Finance Committee Chairman Max Baucus (D-MT), who rarely gives public speeches, laid out his agenda for tax reform. Just for fun, I compared what Baucus told the Bipartisan Policy Center to a speech House Ways & Means Committee Chairman Dave Camp (R-MI) delivered just three weeks ago to a group of Washington lobbyists.
For optimists, there were some points of agreement. For example, both chairmen focused on the importance of a tax code that encourages economic growth and international competitiveness. Both said it is important for Congress to take a hard look at the individual merits of each of the scores of expiring tax preferences rather than mindlessly extending them as a group–as Congress always does.
But after that, the gulf between the two men is simply stunning. Baucus said flatly that any tax reform has to generate more money. “Deficits and debt are not just a spending problem,” he said, “We simply don’t raise enough revenue.”
Camp is in a far different place: “I can firmly say our goal is: One, block massive, job-killing tax increases; and, two—enact…comprehensive tax reform.”
Of course, one can try to parse Camp’s words and conclude that perhaps he’d support smaller, non-job killing tax increases (whatever they are). Or, perhaps, broadening the tax base is, in his fiscal theology, not a tax increase at all. But even this sort of close Talmudic reading still leaves a revenue chasm between Baucus and Camp. And keep in mind that the two chairmen are far more likely to seek accommodation across the aisle than many in their respective caucuses.
Revenue is not the only place where the two men differ. Camp and the House GOP caucus have set a very specific set of goals for a revised tax code: Set two individual rates of 10 percent and 25 percent; eliminate the Alternative Minimum Tax; and move the corporate tax to a territorial system, where the US would tax income generated only in the U.S.
For Baucus, this thinking is exactly backward. In his view, issues such as rates and structure should take a back seat to a broader, macro-economic aim: “We should think about what’s the real reason for tax reform. Why are we doing this?”
To that end, Baucus wants a tax code that reflects changes in both economics and demographics. So, for instance, he wants a revenue code that recognizes the rise of services and technology, and one that addresses the needs of single-parent households.
Camp may be thinking of these issues as well, but his main focus is those low rates.
Finally, there is the matter of short-term tactics. Camp and the House Republicans want a vote this summer on extending all of the 2001/2003 tax cuts. Most Senate Democrats, for their part, want a vote this summer on extending those tax cuts for all but the highest income households. But the always-cautious Baucus does not. He wants to avoid divisive partisan votes before the election.
It is, of course, dangerous to take the public words of politicians too literally. And when given a choice between listening to what they say or watching what they do, it is always preferable to do the latter. But Camp and Baucus are serious guys in important positions. It never hurts to pay attention to what they have to say.
Over the past week or so, Bill Clinton, Larry Summers, and Glenn Hubbard have all made the same suggestion: Congress should extend all of the 2001/2003 tax cuts, due to expire at year’s end, into early next year.
It seems like an awful idea.
I suspect they have different motivations for this advice. Clinton, ever the master political strategist, may have done a calculation about President Obama’s re-election: Uncertainty over Taxmageddon is dampening the animal spirits that drive economic growth. And it is that growth, or its absence, that will largely decide whether Obama will remain in the White House after January.
Thus, Clinton’s public intervention may be intended to convince the president to take that uncertainty off the table now by urging Congress to extend the tax cuts into 2013.
A 3-month delay doesn’t change fiscal reality in any way, but Clinton may be hoping it improves perceptions by getting the end-of-year train wreck out of the headlines. Out of sight, as they say….
Summers, who was a top economic adviser to both Clinton and Obama, may simply be worried about what appears to be another slowdown. “We’ve got to make sure we don’t take gasoline out of the tank at the end of this year,” he said on CNBC’s June 6 Morning Joe program.
Hubbard, a senior economic adviser to President George W. Bush and Mitt Romney, may have something else in mind entirely. He told the Wall Street Journal on May 29 that he’d like to see the tax cuts extended into early next year as well. That would give Romney the flexibility he needs to enact his own substantial tax reduction.
If Congress votes this year to make permanent all the Bush-era tax cuts—except for those for high-income households– a newly-elected President Romney would have much less maneuvering room. The official deficit would look a lot bigger than it does today and Senate Democrats would have plenty of leverage to block Romney’s tax initiatives.
Since it is likely that the debt limit won’t be reached until sometime in the first quarter of next year, Democrats would be happy to force Romney to tie tax cuts for the rich to a painful vote to increase the U.S. borrowing authority.
Of course, while Clinton, Summers, and Hubbard (it only sounds like a white shoes law firm) want to kick the tax debate into next year, they disagree on what to do after that. Clinton and Summers want the tax cuts on those high earners to expire at some point. Hubbard, or at least Romney, would not only continue them, but expand them. And cut taxes for most everyone else as well.
Obama, for his part, insists he is sticking by his guns. He wants Congress to make permanent the 2001/2003 tax cuts for those making less than $200,000 (or couples making less than $250,000) but insists that lawmakers allow them to expire for the highest income households. Of course, Obama said the same thing in 2010 and eventually blinked, agreeing to continue them all until the end of this year.
While both Obama and Romney partisans think there are good political reasons to put off the inevitable until early next year, in the real world a short-term extension of those tax cuts seems like a terrible idea. I can’t think of much worse tax policy than extending virtually the entire Revenue Code for a few months at a time.
The Congressional Budget Office’s latest update, released today, provides a snapshot of fiscal policy in the short run, the medium term, and the long run. CBO disclosed its short-term analysis in May: If automatic spending cuts and tax increases kick in as scheduled at the end of the year, the U.S. could be thrown back into recession. Meanwhile, few quibble that in the long run, demographics and the continued rapid growth in medical costs will require spending that exceeds the capacity of our current tax system.
CBO’s midterm projection, however, is more controversial. The agency warns that over the next decade, continuing temporary tax policies – in particular the 2001/03 personal income tax cuts – will lead to unsustainable levels of annual deficits and debt.
But there is nothing inevitable about this excessively glum estimate. There is a far better alternative.
What if Congress retained the level of taxation set by current law, but collected the money in a much smarter way?
Of course, Congress could just do nothing. Allowing temporary tax policies to expire as scheduled would result in small and manageable federal deficits over the next ten years. However, many aspects of tax policy implied by “current law” are problematic—most notably, the Alternative Minimum Tax would hit an additional 50 million middle and upper-middle class households by 2022.
There is a better way. In an article published yesterday in Tax Notes, Ed Kleinbard, former Chief of Staff of the Joint Committee on Taxation, and I present an alternative post-2012 personal income tax regime, the “Better Base Case”. Quite simply, the Better Base Case would raise the same level of revenue as the CBO’s current-law baseline, but in a way that addresses the most troubling aspects of reverting to the tax laws in place in 2000. Specifically, we would let the temporary tax cuts expire as scheduled under current law and then make the following changes:
- Limit the value of personal itemized deductions to 15 percent
- Permanently patch the alternative minimum tax (AMT)
- Retain the child tax credit at its 2012 level
- Tax qualified dividends at the same 20 percent maximum tax rate that applies to long-term capital gains
- Restore the estate tax to its 2009 form ($3.5M indexed exemption and a 45% rate)
The resulting tax system is more efficient, more equitable, and (most importantly) meets the most basic requirement of a tax system—it raises the revenue required to fund the spending needs of the federal government. If nothing else, it provides a useful benchmark against which to measure other competing tax proposals.
We recognize that the level of revenue implied by the CBO baseline is uncomfortable for many to accept. Indeed, it is more than President Obama has proposed in his annual budgets. But we argue that it represents a minimum level of revenue necessary over the next decade to meet our current spending needs. And despite hyperbolic claims to the contrary, it would not significantly impact people’s work effort, or the pace of economic growth and job creation going forward.
We also acknowledge that an abrupt transition to this new regime would be inappropriate in a still weak economy. The Better Base Case is fully compatible with policies that would provide additional temporary fiscal support, either by phasing in tax increases or pairing them with other more stimulative tax and spending changes.
None of this is to say we oppose additional and more ambitious efforts to reform the tax system. However, those discussions, along with more fundamental debates about the role and size of government, should take place in a stable and rational fiscal context. That is what the Better Base Case achieves.
I recently blogged on Doug Holtz-Eakin’s four-step framework for tax reform. His roadmap—first agree on a progressive tax code, a top rate, and the total amount of revenue to be raised, then cut the tax preferences necessary to accomplish the first three—has generated lots of interest.
But Chuck Marr over at the Center on Budget and Policy Priorities is no fan.
In his own blog, Chuck argues that the Holtz-Eakin model is a fiscal trap that would increase both deficits and income inequality. Thus, he presents his own alternative four-step plan:
1. Let the Bush tax cuts aimed at households making over $250,000 expire on schedule.
2. Agree on how much additional revenue to raise, alongside significant spending cuts, as part of a balanced deficit-reduction package.
3. Agree on specific revenue-raisers while maintaining or improving tax progressivity.
4. Reduce tax rates below their scheduled current law levels only if Congress can cut enough tax preferences to meet the revenue target without gimmicks.
The differences between the two models are subtle but very important. Let’s look at a couple:
Doug, a former director of the Congressional Budget Office and top economic policy adviser to President George W. Bush and the 2008 McCain for President campaign, wants to fix revenues as a share of Gross Domestic Product. Thus, Congress would agree that the new revenue code would raise X percent of GDP in taxes without regard to what revenues would otherwise be under some baseline.
By contrast, Chuck wants Congress to agree on how much additional revenue to raise relative to current law.
Mathematically, you can end up in the same place, but journeys are very different. Chuck would continue the argument we’ve been having since 2001, and it is a debate that has gotten us absolutely nowhere. First there is the hopelessly unproductive squabble over baselines—additional revenue relative to what? That could be resolved if later this year President Obama convinces Congress to permanently extend most of the 2001/2003/2010 tax cuts. But that’s a massive if.
Chuck’s strategy forces Republicans to swallow an in-your-face tax hike—something they are simply not going to do. They are no more likely to accept this than Democrats would agree to a Social Security reform that is presented as a cut in benefits. Framing matters.
The second big difference is the order in which they’d move toward reform. Doug would first fix a revenue target and the top rate, then scale back tax preferences to meet those twin targets. Chuck would first broaden the tax base. Congress would cut rates only after it agrees to the tax hikes it needs to meet its revenue increase target.
Chuck’s fear is that Congress would blink when confronted with painful base-broadening and that the revenue target, not the lower rates, would inevitably give way.
Joe Minarik, a veteran of the 1986 tax reform process who is now at the Committee for Economic Development, is generally supportive of Doug’s formulation, but in his own blog he agrees with Chuck that it makes more sense to get the tax base right and then fix the rates.
As a matter of pure tax policy, I agree with Chuck and Joe. Ideally, Congress should build the best possible tax base and then adjust the rates to meet an agreed-upon revenue target. But I think they misread the psychology of today’s policymakers.
Look at recent history. For decades, policy wonks have urged Congress to eliminate popular tax breaks to help meet a goal of deficit reduction. Lawmakers have responded by repeatedly adding tax subsidies and increasing the deficit.
This is not working. Perhaps lawmakers would do a better job of dumping tax preferences if their goal mixed the sweet of rate cuts with the bitter of deficit reduction.
Sure, Chuck may be right that all this is a Republican Trojan Horse—a clever strategy to lower rates and increase deficits and inequality. Mitt Romney’s tax reform (at least that part he is willing to describe) would do just that and is not, as they say, a confidence-builder.
Still, Doug’s roadmap has the benefit of reframing what has so far been an entirely non-productive debate. Will it work? As I said in my original post, probably not. But it has a chance. Merely repeating the arguments of the past decades does not.
Make no mistake, any attempt at tax reform will be a heavy lift. But an interesting behind-the-scenes debate is brewing among reformers over just how high to aim. And some Republicans insist that big, broad-based reform would be easier to accomplish than a more modest rewrite of the Revenue Code.
The go-long theory, favored by House Ways & Means Committee Chairman Dave Camp (R-MI) and others, works like this: The way to break the logjam over reform is to propose an aggressive, attention-getting, block-buster rate cut. And you finance this ambitious goal by going after everybody’s tax preferences, not picking and choosing among the oxen to be gored.
Such a strategy serves two purposes, they say. First, a big rate reduction—say, bringing the top corporate and individual rates down to 25 percent from today’s 35 percent—would generate the sort of popular enthusiasm that a more modest effort cannot. Who, the Camp camp asks, is going to get excited about knocking the top rates down from 35 percent to, say, 32 percent? It’s a yawner, they argue.
The second benefit to this strategy, supporters say, is that it forces all special interests to take a haircut on their existing tax preferences. There will still be winners and losers, for sure, but because nobody would avoid losing some targeted tax breaks, it would be tougher for lobbyists to protect their clients.
This model is much like the 1986 tax reform, which from its very beginnings was an attempt to knock individual rates down significantly (Ronald Reagan’s original reform would have cut the top rate, for example, from 50 percent to 35 percent). And it is similar to the strategy of the fiscal commission chaired by Erskine Bowles and Alan Simpson, which proposed taking the top rate down to 28 percent.
Of course, the go-prudent camp has different view: It is naïve, at best, to think that a full rewrite of the Revenue Code is possible in the current political environment. It would, they say, be something of a miracle if Congress can agree to any reform at all, much less mega-reform.
This view says take reform one step at a time. President Obama, for instance, has said that Congress should tackle corporate reform first. The more controversial individual provisions could be addressed later.
The cynics in the cautious camp have yet another argument. They say the go-long strategy is nothing more than justification for locking in big rate cuts that are both inappropriate and unsustainable in the current fiscal environment.
And, of course, there is perhaps the most likely option of all: Go home. As they have for decades now, policymakers will talk about tax reform even as they add more targeted tax breaks to the code.
But let’s pretend Congress will enact some reform in 2013. What will it do? Today’s politics is so different from 1986 that I’m not sure how many lessons of that experience apply. And while I’d certainly like to believe that big, broad-based reform is doable, my head tells me it probably is not.
What do you think: Should tax reformers go long, or go prudent?
State taxes and transfers can be an important form of assistance for low-income families. But the amount of government help varies widely among the states. And, importantly, so does what happens to those benefits when such a family increases its wages.
To help understand how those tax and spending programs work, the Urban Institute has created a new interactive Net Income Change Calculator (NICC). The calculator allows users to enter information about family and work characteristics, child care expenses, rent, and program participation. The calculator then provides estimates for taxes and transfers at five income levels so users can see how taxes and transfers change as income rises.
It includes state and federal income taxes, the employee share of payroll taxes, and a wide range of subsidy programs, including Temporary Assistance for Needy Families (TANF), the Supplemental Nutrition Assistance Program (SNAP, formerly Food Stamps), the Supplemental Nutrition Program for Women, Infants, and Children (WIC) as well as subsidies for Housing and Child Care. All rules represent 2008 law.
The calculator shows how different these benefits are, depending on where a low-income family lives. For example, in 2008, a single parent with two children aged 0 and 3 with poverty level wages could have received transfer benefits ranging anywhere between $4,000 in several states and $9,200 (Connecticut) if she participated in TANF, SNAP, and WIC.
In addition, she could have received about $6,700 in federal tax credits and either owed state income taxes or received additional tax credits. For example, in Alabama her state tax bill would be over $300 while in Connecticut she would owe no states taxes. She would also have owed almost $1,300 in the employee side of payroll taxes. We assume her childcare costs, before subsidies, would increase to about $250 per month – some of which could be offset by childcare subsidies. Together, taxes and transfers could have changed this mom’s income from $17,000 in wages to between $27,500 and $32,000 in income and benefits, depending on where she lived.
What happens if that mom gets a job?
A single parent in Connecticut with two young children could have received over $18,000 in transfer benefits if she had no earnings and no income, assuming her pre-subsidy rent was $600 per month. But suppose her earnings increased to $17,000 (poverty level) – spread evenly throughout the year – increases in childcare costs (assumed to be $250 per month before subsidies) and payroll taxes would have reduced her earnings by almost $2,000. Income tax credits and transfer benefits would have then added $16,500 – for a total net income of almost $33,000. If her income increased to twice poverty, she’d have to pay almost $5,600 in subsidized child care costs, state income taxes and payroll taxes. She’d receive about $6,400 in tax and transfer benefits – for a net income of $35,000. Thus, doubling her wages from $17,000 to $34,000 resulted in a net change in income of only about $2,000.
In contrast, the same family in Alabama could have received almost $17,000 in transfer benefits if the parent had no earnings. If her earnings increased to poverty-level, she would have spent over $2,500 on childcare, state income taxes, and payroll taxes, while transfer benefits and tax credits would have decreased to under $15,000. In total, the family’s net income would rise from almost $17,000 to $29,000. If her wages doubled, the combination of declining transfers, increased taxes, and higher childcare costs would have resulted in a total net income of $33,000 – an increase of about $4,000.
The NICC provides a powerful tool to understand both how states differ with respect to taxes and transfers, and to understand how a family’s income changes as a parent increases her earnings. Try it out.
By now, you know the great taxmageddon story: At the end of the year, a lame duck Congress and a new or newly re-elected president will face the confluence of three extraordinary challenges—the 2001/2003/2010 tax cuts expire, the automatic spending cuts adopted in 2010 begin to bite, and the Treasury loses its ability to borrow new money.
But what if that schedule is wrong? What if that third forcing issue—hitting the statutory debt limit—does not happen until sometime in the first quarter of 2013? That is increasingly likely, say the folks who watch this sort of thing. And it would completely change the politics of the coming train wreck.
Here’s what might happen:
Assume President Obama is re-elected. Separating the debt limit from those other fiscal issues strengthens his hand enormously in 2012.
It makes it much easier for him to push Congress to extend the 2001/2003 tax cuts for all but those making $200,000 or more. Without the threat of a government shutdown, congressional Republicans lose their strongest leverage. And they’d have to explain why they forced a tax increase for nearly all Americans in order to preserve tax cuts for a handful of the wealthiest. Worse, they’d look like petulant losers.
Obama could, in that environment, come off as the voice of reason—the role he loves to play more than any other. He could sweeten the pot by offering a deal to delay the automatic spending cuts (which almost no-one supports) and set a date in 2013 by which Congress would enact tax reform and, perhaps, additional spending reductions. He’d try to work a debt limit extension into the mix too. But worse case, he could put it off until say, March of 2013.
The more interesting speculation, however, is about what happens if Mitt Romney is elected President. If he wins in November, there will be no living human in America more anxious to have the debt limit resolved in 2012 than Romney. He would, I suspect, give up almost anything to avoid having to face the debt limit shortly after he is sworn in. I can hardly think of a less auspicious start to his presidency than a knock-down drag-out brawl over increasing government borrowing.
Just think about it. If he asks for a debt limit increase as one of his first acts in office, already-skeptical tea partiers would abandon him in droves. If he didn’t, and allowed the nation’s borrowing authority to expire….Well, no self-respecting ex-Wall Street guy is going to do that.
As a result, a newly-elected Romney would put enormous pressure on congressional Republicans to make the debt limit issue go away. In 2012. That would mean convincing the lame duck Congress to quietly pass a one or two year increase.
Just defeated Democrats, who have spent the past year ripping Republicans for irresponsibly holding the debt limit hostage would, of course, switch roles and hold the debt limit hostage. Their price for dealing: Tax increases. Big. Fat. In-your-face-Grover-Norquist tax increases.
So watch what happens to that debt limit deadline. It could change everything.
At the National Tax Association’s spring conference last week, former Congressional Budget Office Director Doug Holtz-Eakin laid out a path to tax reform in four simple, clear steps. Doug, who was also a top policy aide to the 2008 McCain for President campaign, was absolutely on point. And his analysis was both evidence of how hard reform will be and a possible roadmap to getting there.
His four steps were:
1. Recognize that the U.S. will have a progressive tax code (the flat tax, he said, is, “naïve”).
2. Agree on a top rate.
3. Agree on how much revenue you want to raise.
4. Eliminate or scale back the tax preferences you need to accomplish the first three.
Easy-peezy, as they say.
We should be able to get agreement on the first. With the exception of a handful of dead-enders, as Dick Cheney said in another context, there is a broad consensus in the U.S. that the tax code should be progressive. How progressive, of course, is matter of debate. But for the most part that argument will happen within some fairly narrow parameters. And it is not irreconcilable.
Similarly, with leadership from both parties, we could reach consensus on the top rate and scale other rates down from there. We did it in 1986, though there was some slippage from where that debate started. The fiscal commission chaired by Alan Simpson and Erskine Bowles used the same technique.
The third step may be the key to the whole enterprise–and the toughest to achieve. Without agreement on a revenue number, there is zero chance of a successful tax reform. But to get there, Congress has got to find a way to reframe the current unproductive battle over this issue.
That’s why Doug may be on to something when he talks about setting a revenue goal.
This not the same as arguing about how much we want to raise or lower revenues. Going down that road leads only to re-litigating the 2001/2003/2010 tax cuts and leaves Congress trapped in the toxic vortex of budget baselines. While this makes a small group of budget wonks very excited, it is a road to policy oblivion.
What if, instead, Congress and the President agreed that the new reformed tax code should raise xx percent of Gross Domestic Product in revenue in 2022? No baselines, no snarling argument over whether this would be a tax cut or a tax increase. Just…a number.
I’m not saying that getting there will be easy in today’s political environment. It will, in fact, be extraordinarily difficult. But the prospects for consensus are much higher than if the debate never gets past what to do about decade-old tax cuts.
The last step in Doug’s roadmap is figuring out how to pay for reform. And, oddly perhaps, that might be the easiest bit of all. As Ronald Reagan, Dan Rostenkowski, and Bob Packwood learned in 1986, once the leadership agrees on a rate and a revenue number, it is very hard for the lobbying class to fully protect its clients’ interests.
Sure, there will be some nips and tucks. But the basic outlines of that first draft are always very hard to budge.
Will Doug’s roadmap get us to reform? It’s still very hard to see. But it is at least a plausible path.
Summer is here and that can mean only one thing – the start of movie season. Well, that and California’s annual budget mess. Like a tired franchise that keeps coming back, it’s the same story year after year, sometimes gussied up with computer generated effects or a surprise cameo appearance.
On Saturday, Governor Jerry Brown kicked things off by announcing that tax collections were coming in below projections, and so the state would face a $4 billion deficit by the end of the current fiscal year (June 30th ) if lawmakers failed to take corrective action. Left unchecked, by the end of next fiscal year, the deficit would grow to $16 billion.
If this all sounds familiar, it’s because in every budget cycle since the last recession, the state has started with a projected gap between inflows and outflows. The problem has certainly grown worse lately, as California and nearly all states, have struggled mightily with falling revenues and rising service demands in the Great Recession. But it’s inescapable that lawmakers could have fixed the roof when it wasn’t raining. They didn’t.
This is what’s known in the business as a “structural deficit.” It means that there is an ongoing mismatch between revenues and public spending, regardless of how the economy is performing. Some would attribute this mismatch to a disconnect between what voters want from government and what they are willing to pay for it. Others would call it a failure in government’s ability to provide services efficiently and live within its means.
The problem is that the debate about right sizing government – in California and Washington, DC – typically happens in a fact free zone. No one is talking about the business of government, what it provides, to whom, and at what cost. The truth is we have very little data to underlie this kind of conversation. Budgets are rife with information, and California’s non-partisan Legislative Analyst’s Office does a Herculean job putting out its own materials. What’s missing someone to put it all together. Some nonprofits and advocacy groups are providing a good start.
Also, voters and politicians alike could be more engaged. Instead, California’s budget season usually follows the same plot line: January budget release, May revision, and then a summer of gridlock punctuated by a few high profile protests and maybe a cash crisis necessitating state IOUs. All is resolved in late summer or early fall (well beyond the state’s June 15th constitutional deadline and into the July 1st fiscal year). Or is it? The villain always comes back, and the process begins again.
Maybe this year will be different. The governor is proposing some harsh cuts to health and social services on top of those that have already happened since 2009 as well as converting state employees to a four-day work week (at 5 percent less pay). If voters do not approve his November ballot initiative for a temporary income tax surcharge on high-income residents and a quarter cent sales tax boost, public schools, colleges, and universities are next on the chopping block. Those kinds of cuts, as well as closing 70 state parks, may get people’s attention.
Or, as one LA observer noted, “…we are about to head into the summer, when people are not spending a lot of time paying attention to what is happening in government.” Alas.
Originally posted at the Brookings Institution Up Front Blog on May 17, 2012.
Now that a once-obscure J.P. Morgan Chase derivatives trader named Bruno Iksil has become infamous as the London Whale, I suppose it is time to ask whether what he does should be subject to new taxes.
The question predated Mr. Iksil’s misadventures, of course. Ever since the U.S. financial crash of 2008 and the beginnings of the pending Euro-zone financial collapse, governments have been debating whether securities transactions should be subject to a new tax.
Such a levy could, in theory, accomplish at least three goals: It could raise revenue for countries under great fiscal stress, assure that the financial sector (which often avoids tax) pays a “fair and substantial” share of taxes, and discourage bad behavior and thus stabilize markets.
These last two aims are especially important since the cost to governments of bailing out stupid (at least) financial institutions has run into hundreds of billions of dollars over the past four years.
Of course, such a tax could also have damaging unintended consequences that would damage financial markets.
If they should be taxed, the really interesting question is: How? There are at least three major alternatives—and lots of variations on the theme.
The first option is a financial transactions tax (FTT) that imposes a levy on each trade without regard to profits or losses. Thus, if I buy a share of stock for $10 and then sell the same share for $10, I’d be taxed on the value of both transactions even though I made no money. The European Commission recently proposed such a tax for the EU, and Sen. Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) proposed one in the U.S.
The second option is a financial activities tax (known, sadly, as a FAT). This tax, which has been proposed by the International Monetary Fund staff, is levied only on net proceeds of securities transactions. You could think of it as a Value-Added Tax on financial transactions—which are normally exempt from the VAT.
Just to make things even more interesting, some versions of the FAT would not tax all profits, only those that are very high. They might, for instance, have taxed some of the big derivatives bets that Wall Street placed in the early 2000s.
The third idea, which has been proposed by the Obama Administration, is a direct tax on the balance sheets of large, financial institutions. The idea is that a firm should pay a tax that reflects its contribution to systemic risk—and, thus, its likelihood of needing a taxpayer bailout.
The differences between even the FAT and FTT can be pretty arcane. As New York University law professor Dan Shaviro, who has written a terrific paper for Tax Notes on the subject, says, “It is difficult to imagine a question that initially sounds as tedious as whether we should tax financial transactions or activities.”
But this choice is a very big deal. For instance, taxing every transaction could generate an enormous amount of money, even with a very low rate. A 0.01 percent tax would collect $16 billion Euros annually and the Harkin-DeFazio 0.03 percent tax could raise $350 billion over 9 years. Because the FAT taxes only profits, it would take a much higher rate to generate as much revenue.
And there are other questions: What is a financial transaction? How, in fact, would those derivatives that created so much unpleasantness for J.P Morgan in recent days, be taxed?
Then, there is tax competition. Even if all the world’s major developed countries adopted the levy, what would prevent financial markets from decamping to some warm Caribbean island to avoid the tax?
If you’d like some answers to these timely questions, the Tax Policy Center is sponsoring a panel on the subject on Friday. Panelists include Dan Shaviro, IMF Deputy Director for Fiscal Affairs Michael Keen, Tax Notes contributing editor Lee Sheppard, and AFL-CIO special counsel Damon Silvers. TPC visiting fellow Steve Rosenthal will moderate.