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Pathways to Fiscal Reform in the United States

Pathways to Fiscal Reform in the United States

John W. Diamond
George R. Zodrow
Copyright Date: 2014
Published by: MIT Press
Pages: 432
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  • Book Info
    Pathways to Fiscal Reform in the United States
    Book Description:

    The United States and other advanced economies in the Eurozone and elsewhere face severe fiscal problems. The United States is on an unsustainable dynamic path; absent corrective fiscal policies, federal deficits and debts relative to gross domestic product will continue to increase dramatically. In this book, experts consider possible fiscal reforms aimed at addressing the debt problem, focusing on entitlement programs, budgetary issues and processes, and individual and corporate income tax reform.The contributors address such topics as the interaction of rising health care costs and the level of federal expenditures; alternative methods for evaluating the fiscal health and sustainability of Social Security; the effectiveness of budgetary constraints imposed on the states, including balanced budget amendments and debt ceilings; approaches to curtailing individual tax expenditures and methods for increasing the progressivity of the tax system; and the effects of traditional base-broadening, rate-reducing corporate income tax reforms.ContributorsHenry J. Aaron, James Alm, Rosanne Altshuler, Daniel Baneman, Joe Barnes, Robert J. Carroll, Ruud A. de Mooij, John W. Diamond, Jagadeesh Gokhale, Jane G. Gravelle, Peter R. Hartley, Vivian Ho, John Kitchen, Edward D. Kleinbard, John Mutti, Thomas S. Neubig, Mark V. Pauly, Rudolph G. Penner, Andrew J. Rettenmaier, Shanna Rose, Joseph Rosenberg, Daniel Smith, Eric Toder, Alan D. Viard, Roberton Williams, George R. Zodrow

    eISBN: 978-0-262-32191-4
    Subjects: Political Science

Table of Contents

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  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Contributors
    (pp. ix-x)
  4. List of Figures
    (pp. xi-xiv)
  5. List of Tables
    (pp. xv-xviii)
  6. Preface
    (pp. xix-xx)
  7. Overview

    • 1 Directions for Fiscal Reform in the United States
      (pp. 3-16)
      John W. Diamond and George R. Zodrow

      The severe fiscal problems faced by the United States—as well as many advanced economies in the Eurozone and elsewhere—have attracted much attention in recent years. It is clear that the United States is on an unsustainable dynamic path, as current fiscal policies imply federal government deficits and debt relative to gross domestic product (GDP) that will soon become the largest ever experienced and are projected to continue to increase in the absence of corrective policies (Congressional Budget Office 2013; Auerbach and Gale 2010). For example, in one long-run scenario constructed by Auerbach and Gale, current tax and expenditure...

  8. I Expenditure Programs

    • 2 Medical Spending Reform and the Fiscal Future of the United States
      (pp. 19-53)
      Mark V. Pauly

      The rate of growth in medical spending in the United States and most other developed countries is high most of the time and is commonly higher (over the long term) than the rate of growth in gross domestic product (GDP). Because much of medical spending affects and is affected by government spending and taxation, the growth in this share of consumption expenditures is both more important for fiscal policy and raises more potential problems than consumer spending growth in other sectors of the economy. Given the growing importance of Medicare and Medicaid, the two most important federal health care programs...

    • Discussion
      (pp. 54-63)
      Vivian Ho

      As Mark Pauly notes, the rising share of government spending as a percent of U.S. gross domestic product since the 1960s is almost completely accounted for by increases in federal health care spending. Medicare, Medicaid, and CHIP expenditures made up 21 percent of the FY 2010 federal budget. The federal government’s spending on health care is projected to rise even further. Medicare spending will grow as more baby boomers retire and qualify for federal coverage. The Affordable Care Act (ACA) of 2010 will also expand the federal government’s spending on health care. Expanded Medicaid coverage through the ACA and premium...

    • Discussion
      (pp. 64-76)
      Andrew J. Rettenmaier

      Mark Pauly’s essay opening this chapter, like all of Pauly’s other work I have read, is exceptionally well written, thorough, comprehensive, and explains the economic reasoning behind each key point in ways that economists and noneconomists can appreciate. The chapter progresses through an explanation for the rise in health care spending, how this growth affects government budgets, why tax financing burdens the economy, and the justification for reforming tax-financed health care spending.

      These are the main ideas. Medical care is a luxury good, and consequently, spending rises more rapidly than income. This would not be a problem if medical care...

    • 3 Social Security’s Financial Outlook and Reforms: An Independent Evaluation
      (pp. 77-114)
      Jagadeesh Gokhale

      Social Security is often described as a foundational element of the nation’s social safety net. Almost all Americans are directly affected by the program, and many millions primarily depend on its benefits for supporting themselves during retirement.¹ But the program’s financial condition has worsened considerably since the 2008–9 recession. In their 2007 annual report, the Social Security trustees estimated that the Old-Age and Survivors Insurance (OASI) program’s trust fund would be exhausted by 2042. The trustees’ annual report for 2014 brings the OASI trust funds exhaustion date forward to 2034.² Indeed, OASI tax revenues began to fall short of...

    • Discussion
      (pp. 115-120)
      Henry J. Aaron

      Jagadeesh Gokhale is a member of the small band of scholars who devote themselves in a serious way to the economic analysis of Social Security. He has developed a detailed empirical model for analyzing the long-term effects of the current system and of various alternatives. His goal as expressed through this model is to avoid what he contends are serious analytic shortcomings of the methods used by the Office of the Actuary (OACT). His alternative projections of Social Security’s future differ in important ways from OACT’s. He then uses the model to compare the effectiveness of six reform proposals in...

    • Discussion
      (pp. 121-132)
      James Alm

      The Old-Age Survivors Insurance (OASI) program, popularly known as Social Security, is one of the major social insurance programs in the United States. It is in fact because of this importance that its finances are an essential part of any discussion of the long-run budget outlook for the federal government. At present, these long-run prospects appear somewhat bleak. Such factors as the retirement of the baby boom generation, their extended life expectancies, the recent Great Recession, and the uncertain longer-term economic growth prospects have all combined to suggest that expected future outlays will significantly exceed future revenues. Indeed, in the...

  9. II Budgetary Issues and Processes

    • 4 Federal Budget Reform: Lessons from State and Local Governments
      (pp. 135-162)
      Shanna Rose and Daniel L. Smith

      While the national deficit and debt of the United States have long inspired widespread hand-wringing, there is currently a renewed sense of urgency to put the nation on a path toward fiscal sustainability. Deficit and debt reduction took center stage in mid-2011, when congressional lawmakers refused to raise the nation’s statutory debt limit—effectively threatening to cut off the federal government’s cash flow—unless the president agreed to cut federal expenditures by at least as much as the debt limit increase. After a protracted stalemate, Congress and the president reached an eleventh-hour agreement to raise the debt ceiling and cut...

    • Discussion
      (pp. 163-170)
      Joe Barnes

      Shanna Rose and Daniel Smith have summarized a rich literature on the efforts by state and local governments to constrain the growth of debt through institutional constraints and thus provide an important and timely contribution to the debate over how best to address rising U.S. federal debt.

      This chapter is in many ways a companion piece to Rose’s “Institutions and Fiscal Sustainability” (2010), which features a more extended discussion of how institutional reforms, ranging from referenda to term limits, attempt to bring voters’ preferences and legislative decisions more closely into alignment. Nonetheless, Rose and Smith expand significantly on “Institutions and...

    • Discussion
      (pp. 171-176)
      Rudolph G. Penner

      Rose and Smith provide a useful survey of the role of fiscal limits at state and local levels. They find that the strictest balanced budget amendments may have some impact, but otherwise, constitutional or legal limits on deficits, tax burdens, and spending do not seem very effective in bolstering fiscal responsibility.

      I feel a lot of sympathy for anyone doing empirical work in this field, which presents several major problems:

      1. The first resort of the scoundrels when confronted by a constitutional or legal fiscal restraint is to engage in budget gimmickry. Unfortunately the gimmickry usually shows up in the...

    • 5 The Challenges of Funding U.S. Deficits and Debt
      (pp. 177-213)
      John Kitchen

      The United States and other advanced economies are facing fundamental budget and external imbalances that are unsustainable in the long run under current policies. Large budget deficits in recent years in the United States and sovereign debt concerns in Europe have heightened the attention devoted to public finances and the outlook for public debt. In the face of such challenges, renewed efforts are needed in the United States to undertake fundamental tax and budget reforms. However, with the slow recovery from the recent severe recession and the need to limit short-term economic effects from immediate deficit reduction, successful strategies for...

    • Discussion
      (pp. 214-227)
      Peter R. Hartley

      Kitchen raises some difficult questions about the sustainability of current U.S. fiscal policy. Large deficits have to be financed, and every method of financing them imposes serious costs. Furthermore, the balance of financing is not under the control of the U.S. government but will be determined in the marketplace. Failure to reform the current budgetary imbalance thus exposes the United States to considerable risk of incurring substantial costs of an uncertain nature and size.

      Kitchen points out that there are three main sinks for U.S. government debt: private saving, foreign official purchases of Treasuries, and Federal Reserve purchases that amount...

    • Discussion
      (pp. 228-236)
      John Mutti

      John Kitchen addresses the consequences of fiscal policy choices over an intermediate time horizon, beyond any debate about the need for Keynesian stimulus during a cyclical downturn. Instead, he projects the effects on U.S. output, capital formation, and debt position after five and ten years, depending on how the federal government finances the continuation of current government programs. His analysis clearly demonstrates that any of three common options that might be considered to fund a budget deficit have repercussions that should not be ignored. Identifying these repercussions within a consistent framework is no small challenge. Because he draws on several...

  10. III Individual and Corporate Income Tax Reform

    • 6 Curbing Tax Expenditures
      (pp. 239-272)
      Daniel Baneman, Joseph Rosenberg, Eric Toder and Roberton Williams

      The nation’s persistent budget deficits and rising national debt have driven policymakers to seek politically acceptable ways to cut spending or increase revenue. One recurring proposal would increase federal tax collections by paring back or eliminating tax expenditures—provisions in the tax code that provide special tax benefits for selected taxpayers or activities. President Obama’s National Commission on Fiscal Responsibility and Reform called for eliminating or reducing most tax expenditures and using some of the additional revenue to slash tax rates to reduce the economic burden of federal taxes. The Bipartisan Policy Center offered a similar proposal, and members of...

    • Discussion
      (pp. 273-282)
      Edward D. Kleinbard

      Daniel Baneman, Joseph Rosenberg, Eric Toder, and Roberton Williams have performed two important services. First, they skillfully remind readers in a few pages of the central role that tax expenditures play in explaining both the modest revenues collected by our current income tax and the distribution of the resulting tax burdens. Second, they demonstrate how different approaches to curbing tax expenditures can yield very different distributional consequences, even as they raise the same revenues.

      The topic could not be more timely, in light of the juxtaposition of the body politic’s widespread dissatisfaction with the current state of the income tax...

    • Discussion
      (pp. 283-290)
      Thomas S. Neubig

      As U.S. federal policymakers become more serious about both deficit reduction and federal tax reform, there has been an increasing focus on tax expenditures. Tax expenditures are seen as a form of federal spending and as a potential source of base broadening to lower future deficits and pay for lower marginal income tax rates. Baneman and coauthors’ work provides some important analysis of the distributional effects of three alternative approaches to limiting the value of tax expenditures and thus using the additional revenue for deficit reduction or tax reform.

      I have three general comments on the analysis. First, in addition...

    • 7 Raising Revenue from Reforming the Corporate Tax Base
      (pp. 291-334)
      Jane G. Gravelle

      Advocates of reform of the corporate income tax fall into three camps: those who support a rate cut, those who support revenue-neutral tax reform, and those who propose revenue increases, generally through base broadening. Not surprisingly, it is largely business representatives who favor cutting rates without broadening the base and also moving to a territorial tax (where income earned abroad is exempt). President Barack Obama and other political leaders have supported a rate cut if the revenue loss can be offset with corporate base broadening. Citizens for Tax Justice has urged a revenue-raising reform, while some business leaders have urged...

    • Discussion
      (pp. 335-337)
      Rosanne Altshuler

      The essay that opens this chapter examines a broad range of ideas for reform of the corporate tax system. The policies have one important feature in common: all would increase the revenues we currently derive from the taxation of business income. The author, a noted expert on corporate tax policy, divides her analysis into three sections. The first section presents a large inventory of revenue-raising options. The next takes a step back and considers whether raising additional revenues from the corporate tax system should be off-limits for efficiency and competitiveness concerns. The final section evaluates some approaches to corporate base...

    • Discussion
      (pp. 338-342)
      Robert J. Carroll

      Jane Gravelle provides a catalogue of potential ways to raise revenue from the corporate income tax base. She also evaluates various international reforms, analyzes the broad economic effects of raising additional revenue from the corporate income tax, and considers whether the corporate income tax can be viewed as falling primarily on labor or capital owners.

      Gravelle relies on a number of potential sources for estimates of possible revenue raisers impacts, including the Joint Committee on Taxation’s annual tax expenditure pamphlet, the Congressional Budget Office’s Options for Reducing the Deficit, House Ways and Means chairman Rangel’s 2007 tax reform proposal (H.R....

    • 8 The Dynamic Economic Effects of a U.S. Corporate Income Tax Rate Reduction
      (pp. 343-386)
      John W. Diamond, George R. Zodrow, Thomas S. Neubig and Robert J. Carroll

      The U.S. corporate income tax system has not been changed significantly since the much-celebrated Tax Reform Act of 1986 (TRA86). In the interim, most countries have dramatically reduced their statutory corporate income tax rates below the U. S. rate, prompted in large part by the inexorable forces of globalization and increasing international tax competition (Zodrow 2008). The U.S. statutory corporate income tax rate is now the highest in the world among industrialized countries, sparking concerns about the extent to which the tax system makes it difficult for the United States to compete successfully in the world economy today. These issues...

    • Discussion
      (pp. 387-396)
      Ruud A. de Mooij

      Is a lower corporate income tax rate what the United States needs? Do we expect it to create jobs and boost growth? And is corporate tax rate relief the most pressing concern in U.S. tax policy?

      Diamond, Zodrow, Neubig and Carroll (DZNC) address these issues in two ways. First, they provide a comprehensive review of arguments for corporate income tax rate reduction, based on findings in the literature. Second, they use a computable general equilibrium model developed by Diamond and Zodrow (DZ) to quantify the impact of corporate tax reform on the U.S. economy. In my comments, I focus primarily...

    • Discussion
      (pp. 397-406)
      Alan D. Viard

      Diamond, Zodrow, Neubig and Carroll (DZNC) tackle a timely and important topic, analyzing the impact on long-run output of reducing the statutory corporate income tax rate. Their results support two broad conclusions, both of which are economically plausible. First, when corporate tax rate reduction is financed by the curtailment of traditional business tax expenditures, its impact on long-run output is limited and uncertain, depending on the selection of the tax expenditures to be curtailed and the relative magnitudes of various economic effects that are difficult to estimate precisely. Second, corporate tax rate reduction is more likely to increase long-run output...

  11. Subject Index
    (pp. 407-412)