Tax PolicyFiscal Context and Economic

Concepts

Molly Sherlock

Washington & Lee University

January 23, 2015

The U.S. Fiscal PositionRevenues and Outlays: FY1970 – FY2013

Source: CRS Report R43472, The Federal Budget: Overview and Issues for FY2015 and Beyond, November 4, 2014, by Mindy Levit.

2

Persistent Budget Deficits Increasing Debt

3

Why is Spending Projected to Increase?

4

Changing Demographics are Increasing Pressure on the Federal Budget

5

6

Federal Revenue by Source: 1946-2017FY

46FY

49FY

52FY

55FY

58FY

61FY

64FY

67FY

70FY

73FY

76FY

78FY

81FY

84FY

87FY

90FY

93FY

96FY

99FY

02FY

05FY

08FY

11FY

14FY

17

0%

300%

600%

900%

1200%

FY14-FY19 are estimates

Individual Income Taxes

Social Insurance and Retirement Receipts

Corporation Income Taxes

Excise Taxes

Other

% of GDP

7

Individual Income 47%

Other 6%

Corporate Income 10%

Excise 3%

Payroll 34%

Federal Revenue by Source: FY2013

Why Tax Reform? Raise additional revenue?

U.S. fiscal position is “unsustainable” Over time… spending will have to be cut, or

taxes increased

Improve the system? What does an improvement look like?

Economic tools for evaluating tax policy

8

Economic Concepts: Equity

9

Is the tax system “fair”?

Two concepts for evaluating fairness: Vertical equity

Higher burdens on those with a greater ability to pay Horizontal equity

Equal treatment of equals

Evaluating Vertical Equity

10

Evaluating Horizontal Equity

11

Those with “equal ability to pay” should pay equal taxes

Measuring ability to pay Casualty losses Medical expenses

Similarly situated individuals Marriage penalties Homeowners vs. renters

12

Taxes distort behavior

A goal of tax policy Meet revenue targets

with minimal distortions

Economic Concepts: Efficiency

Balancing equity and efficiency

13

Cutting taxes on capital (investment) income

Wage credits for low-income workers

Economic Concepts: Simplicity and Revenue Sufficiency

14

What makes taxes complicated? Measuring income Taxes as social policy

The purpose of taxes is to pay for the government’s activities

Income Taxes: Computing Taxable Income

15

Average Tax Rates Paid

16

About those “Loopholes”FY2013 Tax Expenditures (billions)

17

Provision Amount

1 Exclusion for employer-sponsored health insurance 294.3

2 Mortgage interest deduction 100.9

3 401(k) plans 72.7

4 Lower rate on capital gains 62.0

5 EITC 55.7

6 Pensions 52.3

7 State and local tax deduction (excluding property tax) 46.3

8 Tax deferral for multi-nationals 41.8

9 Child tax credit 40.8

10 Charity deduction (other than education, health) 39.8Source: US Budget, Analytical Perspectives, FY2013Note: Health insurance estimate includes $113.7 billion payroll tax expenditure; EITC and child tax credit include outlays of $52.6 and $22.4 billion, respectively

And what about those “47%”?

18