The American public is deeply divided over whether to raise taxes to pay for health reform. A fascinating Kaiser Family Foundation review of recent survey data finds that in five polls taken over the past four months, about half of those questioned said they’d be willing to pay higher taxes as the price of reform.

However, the amount of tax they are willing to pay appears to be low, they’d much prefer someone else pay, and they don’t like the idea of taxing employer-sponsored insurance one bit. Most striking, a dispiriting 60 percent think the system can be fixed without spending any more money at all—an outcome that no health economist I know thinks is remotely possible.

As the Kaiser paper notes, much depends on how the question is presented. For instance, 57 percent said they’d pay higher taxes when CBS and the New York Times asked about a plan where “all Americans have health insurance they can’t lose, no matter what” Unfortunately no plan being seriously considered in Washington would cover all of the uninsured. When Kaiser asked if people would be willing to pay more “in order to increase the number of Americans who have health insurance”—a much more realistic description—only 41 percent said they would.

When it comes to the kind of tax increase people prefer, taxing employer-sponsored plans gets a collective thumbs-down, whether the question focuses on the most generous plans or all coverage. No matter how the question is asked, no more than 40 percent of respondents favor such a tax hike, and in most formulations, two-thirds oppose the idea.

So what kind of tax increase does the public like? As President Obama has concluded, two-thirds are happy to raise income taxes on those making $250,000 or more. This proves once again that Russell Long’s old doggerel: “Don’t tax me, don’t tax thee, tax that fella behind the tree” remains as true as ever. Respondents also support raising taxes on cigarettes and booze and, by much smaller majorities, on snack foods and soft drinks.

Obama’s non-starter of a plan to cap the value of deductions for top-bracket taxpayers was favored 55 percent to 40 percent in a June Quinnipiac College poll, although it has been a while since anyone has thought much about that plan.

And an across-the-board tax increase? Just 29 percent of those surveyed support that, according to a June Kaiser poll. With 60 percent in that survey believing that more uninsured can be covered at no cost at all, these results send a powerful and depressing message to Capitol Hill: Without a much better sales job, anything short of free lunch reform will generate a significant public backlash. Good for the critics. Bad for significant changes in the way we deliver and pay for medical care.     

During the presidential campaign, Barack Obama and John McCain profoundly disagreed on many issues, among them climate change legislation and the tax treatment of health care. Now, President Obama seems to be bowing to one of McCain’s poor ideas while resisting one of his better proposals. 

It is funny how the politics of these issues is playing out. Many economists agree that McCain had the right idea on health care—the Arizona senator proposed replacing the current exclusion for employer-sponsored insurance with a generous tax credit. Yet, Obama continues to resist (though with increasingly less vigor) any change in the tax treatment of insurance.

On the other hand, when it came to cap and trade legislation, McCain favored giving away credits to create a market for CO2 pollution. Obama preferred auctioning those rights to pollute. The difference is more than technical. While in the long run both versions promise to reduce carbon emissions by raising the cost of fossil fuels, an auction could generate $100 billion or more annually in new federal revenues. By contrast, giving away the credits would create a windfall for those companies that produce fossil fuels. 

Surprisingly, both Obama and the House Democratic leadership seem to have abandoned the idea of an auction in the face of opposition from Republicans (who called it a huge tax hike) and energy and farm state Democrats (who steered the new subsidy to their local industries). The result: The cap and trade bill passed by the House last week would give away about 85 percent of the credits. 

Before he so quickly capitulated, Obama had big plans for that new revenue. His 2010 budget would have spent about $120 billion on clean energy technology over the next decade. But Obama would have used the biggest chunk, more than $500 billion, to extend his signature middle class tax cut, the Make Work Pay credit. His idea was to use the credit to help offset the higher energy costs for middle-class families. Now, I have no idea where he’ll get the money for either initiative.

I am not so worried about the clean technology subsidies since this sort of industrial policy rarely works anyway. But helping out low- and moderate-income taxpayers who end up paying more to air condition their homes or fuel their cars seems to be a necessary step. Now, my biggest fear is that Obama and Congress will merely extend Make Work Pay without finding the offsetting revenues. Something else for those Chinese bondholders to finance, I suppose.

With so much attention paid to health care, this massive energy bill slipped through the House with barely a notice. Now, it goes to the Senate where, I fear, it will only be made worse. After all, there are still about 15 percent of the credits to be given away.        

 

There’s an interesting exchange on the climate change bill going on over at Capital Gains and Games.  Budget wonk Stan Collander was impressed that “…the White House once again has demonstrated an excellent ability to get Congress to go along with the things it wants.”  Dartmouth economist and former Bush CEA member Andrew Samwick, however, argues that this is backwards.  He thinks the legislative branch should take the lead on developing legislation and the executive branch should take a subordinate role.

Andrew also complained that the legislation would give away most of the permits to industry and that almost all Republicans had sat out the debate.  I agree with him on those points, but not on the leadership point.  I don't see how Congress leads on complex policy issues.  It can (and should) take charge of things like investigations, but only the executive branch has the analytical capability to fully develop policies and only the president has the political capital to advance them.  Congress is designed to advance regional and factional interests.  Those should be part of the policy debate, but I don't see how a coherent policy on something like climate change can get very far if Congress takes the lead. 

In fact, my concern is the opposite of Andrew’s.  I think the President should be standing firmer on fundamental policy issues—such as allocation of permits.  The bill that came out of the House seems almost designed to fail in practice.  The subsidies for consumers are way too small.  (Samwick suggests that a payroll tax offset would make more sense, and I agree.  Obama proposed a version of that, but capitulated to Congress’s giveaways to industry.)  The permit allocation seems designed to reduce emissions in the most costly way possible.  And the capitulation to agriculture was obscene.   (Agriculture is exempt from any emission restrictions and USDA, not EPA, gets to decide about offsets—activities that reduce carbon emissions.  Given that USDA’s mission is to advance the interest of farmers, not the environment, this can’t work out well.)

The House did get the president to go along with its wishes (at least a version of them) and it wasn't pretty.  I dread what might emerge from the Senate.

What if we helped pay for health reform by raising the floor on deductible medical expenses from 7.5 percent of adjusted gross income to 10 percent? That, at least, is an idea leaked to The Wall Street Journal earlier this week by the Senate Finance Committee

The move, which TPC figures would raise about $23 billon over 10 years--about 2 percent of the likely cost of health reform--would lift the floor that was set back in 1986. To get a sense of what it would mean, I asked TPC’s Jeff Rohaly and Rachel Johnson to run some quick numbers.

But first, here’s how the deduction works today: Few taxpayers qualify for the medical expense deduction—only about 6 percent. Those facing catastrophic medical costs will get an average tax benefit this year of about $1,000, while those who benefit the most—taxpayers making more than $1 million--come away with almost $8,000.

It is no surprise that the wealthy do best in this structure. They always do with deductions, as opposed to credits. In addition, I suspect that thanks to the advice of accountants and lawyers, higher income taxpayers are better positioned to time discretionary medical expenses to take maximum advantage of the deduction. 

The other folks who do relatively well with this tax break are seniors. Almost 11 percent take some advantage of the deduction, twice the population at large, and they get an average deduction of $1,500. Most are clustered at incomes of between $50,000 and $200,000. Almost one-third of those making between $75,000 and $100,000 take a medical deduction, and they get an average benefit of about $1,200. Top-bracket seniors do far better. Those making between $500,000 and $1 million enjoy an average tax benefit of more than $6,500, while those earning $1 million-plus get about $9,500.

Raising the floor on tax-deductible medical expenses would chip away at some of those subsidies, but not by much. One reason may be that those hit by the Alternative Minimum Tax already face the 10 percent floor. So, for them, the change won’t matter.

Here are a few numbers: Most of those who get nicked are in the $50,000 to $200,000 income range. They’d face almost three-quarters of the tax increase. But on average, those making between $50,000 and $75,000 would lose only about $170 in tax benefits, while those making between $100,000 and $200,000 would lose roughly $450. At the very top, those making more than $1 million would lose more than half of their tax break, but would still end up saving $4,500. 

Bottom line: This proposal will stir a major fuss in return for relatively little money. Replacing the entire patchwork system of health care tax breaks with a single credit, as John McCain and others have proposed, might make a lot more sense. But that idea doesn’t seem to be on the table. 

    

Bill Gale and Alan Auerbach are nice guys, but they sure know how to ruin a beautiful summer day. I’ve spent the morning reading through their latest long-term budget forecast. It’s not even Noon and I think I need a drink.

Gale, who is TPC’s co-director, and Auerbach, who heads the Burch Center for Tax Policy and Public Finance at Berkeley, have done this exercise for the past few years--each iteration more depressing than the last. The story this year: Long after the economy recovers and returns to full employment, long after the TARP and the auto bailouts are history, the U.S. will face massive and unsustainable deficits. Don’t let anyone tell you this is a temporary problem that will fade with the recession. It isn’t and it won’t.

Auerbach and Gale build their forecast on what they consider realistic assumptions about future policy. For example, they extend the Bush tax cuts (most of which President Obama vows to continue), they extend the “patch” for the Alternative Minimum Tax, they freeze but don’t cut physician payment rates under Medicare, and they allow the recent stimulus spending and tax cuts to end as scheduled.

And for all the recent arguing over baselines on TaxVox and elsewhere, Auerbach and Gale show that over the long run it doesn’t matter much which projections you use. Whether you prefer the Obama Administration budget or the policy assumptions of Auerbach and Gale, we will be in the same soup. And either way, we (and our children) will be neck deep in boiling broth.

A few of Bill’s and Alan’s numbers tell the story. Under the Obama budget, Washington will spend 24.5 percent of GDP in 2019, even with the economy operating at full speed. The projected deficit of 5.5 percent of GDP would be the highest in 60 years, except for the deep recessions of 1983 and today. This, they conclude, will be “problematic.” Indeed.  

By 2019, we’ll be spending more than $250 billion on interest on the debt. Think about that for just a minute: We are in the midst of a historic battle in Washington over how to find $150 billion-a-year to pay for health reform. Yet, Treasury will be blissfully writing checks for $250 billion just to pay the vigorish to China and other increasingly nervous lenders.

The long-term bottom line is worse: Gale and Auerbach project that by mid-century, the chasm between revenues and spending will reach 8 percent of GDP. By the end of their forecast period, 2085, it will hit 11 percent. If you prefer the Obama budget forecast, the gap will be a mere 10 percent.

This is, of course, impossible. The only question is: What are we going to do about it?      

One proposal to help finance health reform would tax fast food, salty snacks, and/or sugary drinks like soda.  While critics see government meddling in citizens’ private lives, supporters of a “junk food” tax say such a levy could help finance expanded insurance coverage as well as lower health care costs by inducing people to switch to healthier diets. Taxpayers pay much of the expense of obesity-related disease through Medicare and Medicaid. 

Would a junk food tax really reduce obesity?  Economic theory says that by raising the relative price of unhealthy foods that contribute to obesity, the tax would motivate people to spend more of their income on foods that are healthy.  As consumers abandon costlier junk foods, obesity rates would fall, and so would health care costs. At least that’s the theory.

In practice, a lot would depend on how the tax is designed.  For example, a tax on chips could result in people choosing to buy more cookies for their afternoon snack.  Similarly, a tax on soda might lead people to drink more beer.  For a tax to be effective at reducing obesity, consumers must not respond by switching to other unhealthy foods not covered by the tax.

Lisa M. Powell and Frank J. Chaloupka recently combed the literature to find out what we know about how junk food taxes affect obesity.  Their answer: not much.  Most studies have concluded that changes in the price of unhealthy foods have relatively small effects on obesity rates, although one found that residents of states that repealed junk food taxes were more likely to experience subsequent obesity gains. Powell and Chaloupka concluded that it would probably require a “nontrivial” change in prices to significantly affect obesity rates. In other words, it would take a heavy tax to keep the weight off.

Like other sin taxes, a tax on junk foods would be regressive.  That is, it would disproportionately affect low-income families who consume a greater share of those goods.  However, this story may not be so clear-cut.  Several studies have found that low-income households are especially sensitive to changes in the price of unhealthy foods, suggesting they will avoid much of the tax (and the financial hit) by reducing junk food purchases.

Moreover, low-income communities are among the most affected by obesity-related diseases such as Type II diabetes and heart disease. If a junk food tax helped change that pattern while also providing revenue to improve access to health insurance, its net effect could be extremely progressive (Len Burman has made a similar point in the context of a VAT). 

A final stumbling block lies in defining junk food.  Are high-calorie sports drinks junk foods or useful exercise aids?  What makes a sugary drink healthy enough to avoid the tax?  Do O.J. and apple juice make the cut?  The United Kingdom has spent years trying to define a potato chip (the issue is still not fully resolved).  Wherever policymakers draw the line, food manufacturers will try to make their product appear to be on the right side of it.  Thus a junk food tax might precipitate more changes to how foods are packaged and sold than to what people actually eat.

Unless Congress acts in the next six months, the estate tax will be repealed in 2010 and then revert to its 2001 parameters — substantially more burdensome than current levels — in 2011. This bizarre policy makes it very likely that Congress will reform the levy by the end of this year, but it’s unclear exactly how.

 

A recent paper co-authored by Doug Holtz-Eakin, former CBO Director and chief economist for the McCain Campaign, argues that Congress should permanently repeal the estate tax and reap the economic rewards. Among them: higher national saving, creation of over one million new jobs, and billions of dollars in new investment. Unfortunately the paper — perhaps because it relies on back-of-the-envelope analysis rather than empirical data — gets the economics all wrong.

 

Holtz-Eakin and co-author Cameron Smith hypothesize that the estate tax reduces economic growth because small-business owners, who are motivated to bequeath wealth to their heirs, are less inclined to generate wealth when their estates face high marginal rates. Thus, they claim estate tax repeal will increase small business payrolls by 2.6 percent (1.5 million new jobs!) and boost investment by 3.0 percent, while reducing the nationwide cost of capital by between 0.1 and 0.4 percentage points and unemployment by almost a full percentage point. These are fairly remarkable claims for a tax that directly falls on only 0.2 percent of decedents, or 6,000 estates.

 

In truth, while we don’t really know the exact impact of the estate tax on saving and job growth, most studies suggest that the impact is small—it may modestly increase saving and job growth or it may actually reduce them by a bit. The biggest reason for this ambiguity is that taxpayers accumulate wealth for many reasons. The opportunity to bequeath it to their heirs is one, for sure. But they also do so to pay children and others for services, protect against high retirement related expenses, and to donate to charity. Only in the first case would the estate tax be expected to reduce saving. And even in that case, the effect is ambiguous.  If a taxpayer intends to give a certain amount to his heirs, an estate tax requires more saving, not less, to meet the after-tax bequest target.

 

More important, the estate tax can’t have much effect on hiring by small business because hardly any owners ever face the estate tax. Most small businesses are worth far less than the exemption level (currently set at $7 million per couple and higher for many small business owners who value their firms at below market price). We estimate that only 100 small businesses and family farms would pay any tax in 2009, assuming current law is extended.

 

Holtz-Eakin and Smith also fail to account for the net effects of repealing the estate tax. With no tax on estates, the lost revenue will have to be made up elsewhere. Not only would Treasury lose nearly half-trillion dollars over ten years that would have been collected directly by the levy, but also billions more that would be lost due to the new gaping hole in the tax code if the estate tax no longer serves as a backstop. JCT estimates that the reduction in income tax receipts accounts for about 20 percent of the cost of repeal. Depending on how this other revenue is generated — or if it’s collected at all — the estate tax repeal could depress future economic growth.

 

When Congress addresses estate tax reform in the next six months — and it will — I hope the wide body of economic evidence, and not opinion, will help guide its decision.  

A recent blog post at TheEconomist.com nicely summarizes California’s fiscal mess.  It’s an exaggeration to say the state suffers from “extraordinarily low levels of taxation”—its revenues rank 10th in the nation on a per capita basis, 18th as a share of personal income. But California has been captive to a “something for nothing mentality” since at least the recession of 2001 and probably back to 1978, when voters slashed property taxes in half without relenting in their demands for schools, parks, roads, etc. (See also the Washington Post.)

Of course, as I’ve written before, neither living in denial nor running up deficits are uniquely Californian.  And TheEconomist.com, among others, is right to point out that tax hikes and spending cuts in California and other states could counteract the federal stimulus.

But is California really “too big to fail”?  Should the federal government put aside concerns about moral hazard and bail the state out as it did AIG, the auto industry, and many other concerns perhaps less deserving than school kids and poor families?

As the world’s 8th largest economy, California almost certainly generates spillovers.  Still, it’s hard to imagine the state defaulting on its debts.  More likely, it will be forced to borrow at higher cost.  This too-familiar risk premium has not really been passed on to California’s local governments before, and probably won’t be this time either.  If the state is too small to move the rest of the California municipal debt market, it’s unlikely to trigger a global financial catastrophe.

Recall too that California didn’t get into this mess through exotic investments or off balance sheet accounting.  Like most American households, it simply lived beyond its means (or what voters agreed to pay). 

Although it might be nice for the feds to provide political cover for unpalatable choices like repealing Prop 13 and the constitutional requirement that 2/3 of the legislature must approve new budgets, the price in terms of foregone state autonomy may be too high.  (Just ask the banks who want to return their federal bailout money.)

More generally, it may be a great idea to enact a new system of federal aid or general revenue sharing to avoid this predicament in the future.  But it’s not clear that a new, more rational system will emerge out now.

Note to critics of the public plan option for health insurance: This debate is over. You lost. In 2007, more than 45 percent of all medical costs in the U.S. were paid by government, vastly more than the one-third funded by private insurance.   

Many Americans already have access to public coverage. There is Medicare for those over 65, Medicaid for the poor, SCHIP for kids, coverage for the active military, and for many veterans. Together, the share of medical spending paid by government has grown from one-third in 1970 to nearly half today, according to the Current Population Survey. If your definition of “public plan” includes insurance available through highly-regulated private carriers to federal, state, and local employees, the numbers are even bigger. And, of course, there is the quarter-trillion dollar government tax subsidy for health insurance.  

But even using the most narrow definition—those getting direct government coverage-- more than 80 million Americans already have such insurance. That’s half as many as have employer-sponsored insurance, but it’s still a lot of policies.   

Of course, among those 65 and older, far more have Medicare than have private coverage (many have both). Nearly a quarter of all children under 18 are covered by the government.

Public plans have been a pillar of health insurance in the U.S. since the 1960s. We can have a perfectly good argument about whether these plans work as well as they should, whether there are markets where private insurance is more appropriate than public coverage, or how we should structure a public plan. But talking about government coverage as if it is the insurance equivalent of a four-leaf clover is just bizarre.  

It is especially odd to hear the American Medical Association grumble about public insurance. Back in the 60s, the AMA opposed creation of Medicare and Medicaid, never imagining that government would pay about one-quarter of the cost of physician office vists and clinical services as it does today.

It is no surprise that critics of health reform would revive the old Harry and Louise argument that government is trying to take over your health care. But if that’s a problem, it has been one for decades.    

Senate Finance Committee Chairman Max Baucus (D-MT) is floating the following trial balloon: Congress would fund part of health reform with a cap on the tax exclusion of employer-sponsored health insurance but only at a level “significantly above” the cost of the standard plan offered to federal employees. The measure would also exclude policies bargained under current union contracts. In a bit of unsenatorial understatement, Baucus told reporters on Tuesday that this version of the cap “wouldn’t affect very many people.” Or, he might have added, raise very much money.

So why would Baucus push so hard for a cap that doesn’t tax many policies? My best guess: He’s playing the old camel’s nose under the tent game—getting the tax hike on the books even though it won’t raise much revenue for years.

It is simple to design such a plan. Just allow generous tax-free policies today, but freeze tax-exempt premiums at current levels. Over time, medical inflation will do the rest. As the costs of health care (and premiums) rise, that fixed cap will hit more policies.

Remember the rules of the game. President Obama says health reform must pay for itself, but over 10 years. That opens the door to a back-loaded tax system that generates relatively little today, but big bucks by the end of the decade. 

It is all about how you index the cap. And I suspect that’s where Baucus is headed. Various forms of inflation adjustments may seem like mere technicalities to voters—a definite plus for politicians—but the way you index a cap turns out to be a very big deal.

To see why, TPC took a preliminary look at three options—indexing the tax-free premium level to medical cost inflation (the most generous design), tying it to growth in the Consumer Price Index, or not adjusting at all for inflation, effectively freezing the cap indefinitely. In one model, indexing to medical costs would generate just $62 billion in income taxes over 10 years, while not indexing it all would raise 10 times as much, or more than $600 billion. Indexing to CPI would generate about $450 billion.

For an idea of how fast revenues build if the tax-free premium is not adjusted at all for inflation, the design TPC modeled would raise just $7 billion in 2010, but $136 billion in 2019. Keep in mind that the plan we used (about $5,600 for singles and $13,800 for family coverage) was probably less generous than what Baucus has in mind, but you get the drift.

Now, a cynic may say an unindexed cap is unsustainable--pressure would build to raise it as inflation eats away at the value of a tax-free policy. That may be true, but it isn’t Baucus’ problem. He’ll get credit from the Joint Tax Committee based on the assumption that his plan will remain in place.      

In a sense, Baucus may be trying to avoid a replay of catastrophic health reform back in the late 1980s. Old Washington hands remember that Congress passed a law to cover high-cost medical expenses, but had to repeal it even before it took effect. Why? Because it was easy for critics to gin up opposition to a measure that raised taxes right away but didn’t boost benefits for years. That may have been fiscally prudent, but it was a political disaster. Baucus, it seems, isn’t going to that mistake again.    

    

Until now, unions have been among the strongest critics of paying for health reform by limiting the tax exclusion for employer sponsored insurance. But on Monday, a well-connected labor lobbyist told me a deal could be done. “It all depends,” he said, “on what the cap looks like.”

Remarkably, in just a few weeks, lawmakers seem to have moved beyond the argument over whether the exclusion should be capped. Now, they are debating how. It is not easy. There are caps based on employee income, the value of the insurance, or both. There are caps tied to the actuarial value of coverage, or linked to geography. Then, there is the issue about how to index a cap.

First, a bit of boilerplate: Today, workers can get tax-free health coverage from their employer. Because this subsidy is excluded from taxable income, it is worth more to high-bracket workers than to those earning less. And the exclusion is very costly. In 2007, it reduced federal revenues by nearly $250 billion—about $145 billion in income taxes and $101 billion in payroll taxes.

With that kind of dough on the table, even a cap on the exclusion is a tempting way to help pay for a health reform. But what should it look like? 

If the goal is to raise cash, the simplest option may be to put a ceiling on the value of tax-free insurance. President Bush’s Tax Reform panel, for instance, would have limited the exclusion to $5,000 for single coverage and $11,500 for families, and indexed the cap to the Consumer Price Index. Because health premiums rise so much faster than the CPI, this design rapidly erodes the value of the tax break and raises lots for the Treasury.

But the commission's job was to reform taxes, not health policy. The Urban Institute’s Stan Dorn, seeking a more equitable exclusion, would tie the cap to the actuarial value of policies, not their price. In other words, benefits more generous than average would be taxed. Paul Van de Water, however, argues that such a structure would be too complicated to administer and might discourage employers from offering higher-quality plans.

While Stan would look to the value of benefits to measure “fairness,” others have different benchmarks. For instance, lawmakers from states where health costs (and, thus insurance premiums) are higher than average favor some geographic adjustment to the cap. Paul Fronstin found typical premiums for the same type of policy can vary by nearly 60 percent among states. Small business premiums can vary by more than 100 percent from state to state.

A regional adjustment may be politically attractive in the Senate, but it will also soak up a lot of potential revenue. Rather than scaling back the subsidy from a national average in lower-cost states, Congress is instead likely to just sweeten it for high-cost jurisdictions.     

Finally, some unions to prefer to base a subsidy cap on worker income rather than the value (however measured) of the insurance. Labor’s interest in this matter is no surprise since unionized workers are far more likely to have coverage that exceeds the Tax Panel’s limit than employees of non-union shops, according to a Tax Notes article by Eliza Gould and Alexandra Minicozzi. At the same time, union wages may well fall below an income cap.

Lots of really interesting policy questions to chew over, and no obvious answers. TaxVox will look more closely at each of these ideas over the next few weeks.           
 
         

San Francisco Mayor Gavin Newsom recently proposed a new 33-cent tax on a pack of cigarettes to help pay for the city’s annual $10.7 million litter-collection program, which includes removing cigarette butts from gutters, drainpipes, and sewers. Though this litter tax may be unique, San Francisco is not alone in targeting sin taxes this year. At least 25 states want to raise tobacco taxes, and 12 would either create or increase taxes on alcohol. While smoking, drinking, and littering are relatively easy political targets when more tax revenue is needed, raising sin taxes to fill large and growing budget deficits during a recession might be more regressive and less countercyclical than other options. What’s more, in the case of city taxes, they may not raise much additional revenue.

Proponents of sin taxes typically argue that alcohol and tobacco have relatively inelastic demands, and the taxed behavior is associated with additional social costs, particularly for health care. However, there is a trade-off between these two arguments: If the tax deters the “sin,” it will raise less revenue.

Many sin taxes, especially cigarette taxes, can be regressive. In 2008, 34 percent of individuals with incomes between $6,000 and $12,000 said they smoked, compared to only 21 percent of all Americans, according to a Gallup poll. Also, the 2007 Consumer Expenditures Survey reported that individuals in the lowest income quintile spent 1.7 percent of their after-tax income on alcohol, compared to only 0.6 percent for those in the highest quintile.Regressive taxes are even less desirable during a recession, when low-income individuals may reduce other consumption to pay the higher taxes on alcohol and cigarettes. All else equal, one would prefer raising a less regressive tax.

Moreover, since demand for these products is relatively inelastic and tax rates may differ from one neighboring jurisdiction to another, higher taxes may result in more evasion, not less consumption. Michael Lovenheim has used data from the Current Population Survey to show that raising taxes in certain states actually increases cigarette consumption due to bulk purchasing and shifts in where cigarettes are bought. Goolsbee, Lovenheim and Slemrod concluded that tax-free Internet purchases of cigarettes have cut tax revenues by roughly 8 percent.

In what may be more bad news for San Francisco, David Merriman found that among a random sample of littered cigarette packs in Chicago, roughly 75 percent were purchased outside of the city. The average price difference between jurisdictions in Illinois is 49 cents per pack, and Indiana has a 41-cent per pack lower average tax rate than Illinois. California’s tax rates differ even more -- on average, by 78 cents per pack across jurisdictions in the state. Therefore, a tax increase on cigarettes in San Francisco might have a hard time putting a dent in the cigarette litter on the streets, or in paying the bill for cleaning it. Rather, it will further encourage people to buy their cigarettes before heading into the city.

In the end, San Francisco may be better off raising fines on those caught littering or selling cigarettes to minors. On the other hand, with San Francisco facing a roughly $500 million budget shortfall this fiscal year, a politically easy tax hike on “sin” might trump equity and efficiency arguments.

As I promised in last Friday’s TaxVox post, here is TPC’s estimate of the 2012 distribution of President Obama’s tax proposals in the 2009 budget, measured against the administration’s chosen baseline. That baseline looks a lot like current policy: extend the Bush tax cuts, index and make permanent the 2009 estate tax, and permanently patch the alternative minimum tax by indexing forward the 2009 parameters.

How does that shift the bottom line? Against the more expansive baseline, some people pay more tax, but they are way up the income scale.

By design, Obama’s proposals would yield virtually no tax change overall, but tax shifts would differ substantially across quintiles (top figure). The lowest 20 percent—or quintile—would see its after-tax income rise by just over 4 percent, the second quintile would get just over half as much, and the next two quintiles would reap after-tax income boosts of 1 percent or more. Only the top fifth would see its tax bill rise, pushing its post-tax income down 1.5 percent. That looks like a pretty progressive tax bill that would be roughly revenue neutral to boot—measured against a fiscally irresponsible baseline.

Break down the top quintile further and the progressivity continues further up the income scale (bottom figure). On average, tax units in the 80th through 95th percentiles would get small tax cuts. Only the top 5 percent would suffer a drop in after-tax income, and for the least well-heeled four-fifths of them, income would dip an average of just 0.7 percent.
Obama would reserve his largest hits for the big guys, clipping after-tax income by more than 5 percent for the top 1 percent. Candidate Obama promised not to raise taxes on the bottom 95 percent of households and his first budget makes good on that promise.

So what is it that makes this view of the president’s tax plan look so much more progressive than the one I showed last Friday? The answer is pretty simple: last week’s story combined the effects of the Bush and Obama tax plans. Bush cut taxes for everybody but heavily favored the rich. Obama first assumes that many of those regressive tax breaks will remain in place but then turns around and raises taxes on those at the very top of the income distribution.  Combine the two and almost everyone gets a tax cut.  If you accept the immortality of the regressive Bush tax cuts as a given, add Obama’s new refundable credits, and toss in higher tax rates for the highest-income taxpayers, you end up with a highly progressive mix.

Following last month’s release of the Treasury Green Book, the Tax Policy Center reworked its distributional analysis of the tax proposals in President Obama’s 2010 budget. We learned many new details about specific tax provisions, including the practical definition of who has enough income to face higher taxes. The bottom line? You have to have a lot of income to be in Obama’s crosshairs.

Compared with current law, almost everyone would get a tax cut in 2012 from the budget’s tax plan, as Howard Gleckman explained here on Tuesday. On average, households in each of the first four quintiles (or fifths) of the income distribution would see their after-tax income rise by between 4 and 5 percent; even those in the top quintile would get a 3-percent income bump. That’s not a lot of wealth sharing: a little shifts to lower-income households because Obama proposes to make refundable tax credits permanent, but the cuts run across the board.

Go a little higher up the income scale and you find that many people in the top quintile do well under the president’s plan. Those in the 80th to 95th percentiles would see their after-tax income rise more than 4 percent on average, and the 95th through 99th percentiles would get 3 percent more. Only when we reach the 1 percent with the highest incomes do the gains tail off and we have to climb to the rarified top one-tenth of one percent to see a small tax increase—yielding a 0.1 percent drop in after-tax income. That’s no surprise, of course. We heard repeatedly during the campaign that Obama would give tax cuts to 95 percent of working families.

I can already hear some of you objecting that I’ve biased my findings by measuring the budget proposals against current law, which includes a big tax increase after 2010 when most of the past decade’s tax cuts would sunset. Howard blogged on the choice of baseline earlier this week and subsequent comments churned through the alternatives. Next week, I’ll show you the graphs depicting how the tax changes stack up against the administration’s baseline—extend the Bush tax cuts, fix the estate tax at 2009 levels, and permanently patch the AMT (all for the tidy little cost of  $3.2 trillion from 2009 through 2019). If you want to peek at the results sooner, you’ll find the relevant table on our website.

Suffice it to say for now that the tax proposals in President Obama’s 2010 budget are far from the massive redistribution of income we heard so much about during last year’s campaign.

President Obama appears to be ever-so-slowly backing away from his hard-edged campaign opposition to capping the $246 billion employer-sponsored insurance tax exclusion as a way to help pay for health reform.

It’s the typical Washington dance. First, on June 2, the President met privately with two dozen Senate Democrats to talk about health reform. Senate Finance Committee Chairman Max Baucus (D-MT), who favors curbing the exclusion, told reporters after the meeting that the President was now willing to consider some limits on the tax subsidy. Another Democrat, Chris Dodd of Connecticut, heard it differently, telling the Wall Street Journal that Obama was not budging. Finally, a White House spokesman ended the day with this: "The president made it clear during the campaign that he has serious concerns about taxing health-care benefits.”

Yes, he did. But the White House was not saying Baucus misheard.

Washington old-timers have seen this before. Remember George H.W. Bush’s campaign pledge: “Read my lips, no new taxes.” Obama’s election promise may be just as short-lived, though without the same dire political consequences.  

All of this will result in a few weeks of serious inside-the-Beltway reading of entrails. But my own sense is that Obama will inevitably accept a curb on the exclusion. He’ll do so reluctantly, at least in public, to placate unions and others who insist the exclusion is untouchable. But, as we’ve seen, Obama, unlike the most recent President Bush, is not a my-way-or-the-highway kind of guy. His governing style appears to tilt much more in the direction of my way…or your way.

Even before Obama’s trip the Hill, OMB Director Peter Orszag drew his own line in the sand. In his blog (does Peter never sleep?), Orszag wrote, “We are insisting that health reform be deficit neutral even over the next five to 10 years, through scoreable offsets such as savings within Medicare and Medicaid and (as necessary) additional revenue.” 

This means one of two things: Either health reform will be slowly phased-in over the next decade or more—a step that will allow lawmakers to finesse the offsetting tax hikes as well. Or Obama will have to swallow an exclusion cap. Once Congress is through, the kind of Medicare and Medicaid savings Orszag is thinking about will not add up to a lot of money—at least not in the context of a $1.5 trillion reform plan. And there just is no other politically-acceptable place to go to raise the kind of tax revenue the President will need.

Health reform is too important to the President for him to allow it to sink on the fine points of financing. As long as Congress is prepared to take the heat for this, my sense is that Obama will go along. Now, all the policymakers have to do is figure out how to design a cap. TaxVox will have more to say about that in the coming days.