Deficit Reduction. Tax Reform, and Budget Baselines
How can it be that one commentator can blast the tax reform plan proposed a few weeks by the co-chairs of President Obama’s fiscal commission as a tax cut for the rich while another, looking at exactly the same proposal, sees it as a tax increase?
It’s all about budget baselines. There is nothing more boring, even to budget wonks, but the reference point against which you measure tax changes is critical to how you see those proposals. It doesn’t help that in today’s fiscal debate there are at least three different baselines floating around. Unfortunately that makes it easy for politicians and their partisans to pick the one that helps advance whatever argument they want to make. And make no mistake: This is all about politics, not merit.
Do you want to compare tax changes to the law that applied in 2009? Or would you prefer to compare those revisions to the Tax Code of a decade ago? Or how about measuring it against your best guess of what the law will be five years from now? This is something like a football game where you don't win by scoring more points than your opponent, but by piling up more than you were supposed to score in a pre-season game scheduled for next August. For a fan, this can be somewhat, let us say, disorienting
But why should anyone who does not own a green eyeshade actually care? Here’s why: Look at what would happen to the highest-earning one percent of households (those earning more than $2 million on average) under one variation of the plan offered by the Obama fiscal commission co-chairs, Erskine Bowles and Alan Simpson. This proposal would eliminate all deductions, credits and exclusions except for the earned income credit and child credit, sharply reduce income tax rates, and continue to exclude employee benefits from payroll tax. The Tax Policy Center estimates it would result in an average federal tax rate of 33.7 percent by the time the proposal is fully effective in 2015.
No argument so far. But is a 33.7 average tax rate a tax cut or a tax increase? Depends on what you measure it against. Take a trip with me through the budget accounting looking glass to see what’s going on.
If you compare Bowles-Simpson to the law that applied at the end of the Clinton Administration, it turns out to be an average tax cut of $8,000 for those top one percent of earners. That’s because under this baseline (called current law since today’s law calls for all the Bush-era tax cuts to expire) their average tax rate would be 34.1 percent, a bit higher than the 33.7 percent they’d pay under Bowles-Simpson. Thus, critics on the left can shout “tax cut for the rich.”
But compare the plan to the law that was in effect last year: Assume the 2001 and 2003 tax cuts endure for everyone, the AMT remains patched, and the estate tax comes back under 2009 rules. Now, Bowles-Simpson raises taxes by an average of $76,000 for that top one percent. Why? Because under this “current policy” baseline, the average tax rate for these lucky duckies would be just 30 percent, much lower than the 33.7 percent they’d pay if Bowles-Simpson becomes law.
Still with me? Great. Because it turns out that Bowles and Simpson scored their own proposal with yet a third baseline developed by the Congressional Budget Office. That one assumes some tax cuts are extended while others are not. I’m not even going there.
The root of this problem lies with the massive and growing uncertainty over tax law. These days, huge chunks of the Revenue Code are temporary. Individual rates that were set in 2001 are due to rise in a month. The Alternative Minimum Tax would have hit close to 30 million middle class households by now. Thanks to years of “temporary” fixes, 85 percent remain exempt– except the most recent fix expired a year ago. Do you assume that Congress continues to protect these middle-class voters? Or that is will extend the Bush-era tax rates for everyone? Or for no one? Oy.
This is hardly the first time politicians have played the baseline game. For instance, when Obama submitted his first budget, he assumed that nearly all of the Bush-era tax cuts and the AMT fix were permanent and thus built into the budget baseline. That way, he could propose extending them without having to account for the nearly $3 trillion ten-year cost. After all, if you assume they are already the law, continuing them costs nothing.
People often ask which baseline is right. My honest answer: I have no idea. TPC’s modelers measure tax changes relative to both current law and current policy. My own preference is to assume the Bush tax cuts will be extended—both because I suspect that’s what is going to happen and because most normal people are likely to compare tax changes to what they pay now, not what they paid a decade ago. But it would be nice if, as we continue to play the budget game, we could at least agree on a way to keep score.