Professor of Economics and Law James Hines discusses the most sensible way to pay for the federal government, noting that the answer lies largely in higher tax rates, not in the many popularly-discussed alternatives. November, 2021.
0:00:01.2 Christie Baer: Alright. Well, welcome everyone. I'm thrilled to have you here for this incredibly popular talk, at least by RSVPs and regrets. So either... You're either here because you're super excited about it, or the people who are not here wish that they were. So nothing like inspiring fear of missing out among other people. I would say in terms of as far as Thursdays goes, you're already winning. I am Christie Baer, I'm the Assistant Director of the Center on Finance Law and Policy. We hold these lunch talks every month as a chance for U of M faculty to test ideas and to incite controversy, to get comments from their accomplished colleagues across the university. One of the great things about U of M is that every sidewalk leads to a top 10 program. So we have... We don't have just one good school, we have a collection of really, really good schools that make a strong team, and so these talks are a chance to kinda take advantage of that. So our speaker today is Jim Hines. He is the L. Hart Wright Collegiate Professor of Law at the law school. He's the co-director of the Law and Economics program at the law school.
0:01:19.7 CB: He's the Richard A... This is a lot of names. The Richard A. Musgrave Collegiate Professor of Economics in the Department of Economics, the Research Director at the Office of Tax Policy Research at the Ross School of Business, and on top of all of those things, a research associate with the National Bureau of Economic Research. So suffice it to say, Jim is like economist, economist, economist. And I would also add to this that he might be clairvoyant because this talk was booked before Congress made it so incredibly relevant. If you are a student, you can take one of his classes, it would be impact economy, maybe international corporate tax, taxation of individual income. He has been at the University of Michigan since 1997, a million years ago. He was at the department, the US Department of Commerce. And what I like about Jim, having had dinner with him a couple of times, is that he is very good at explaining complicated things in a funny and interesting way. So the talk today is he's going to talk about the controversial view, hearsay one... Hearsay. I never say that word right, I might say that the best way to pay for federal spending would be to raise taxes and especially to tax the rich.
0:02:51.3 CB: Those of you who haven't been here in a little while, you are welcome to along the way ask questions by putting them in the chat, and you can interrupt in that way. You can also raise your hand using the little icon thing. If you have a question that you're not sure if it's a good one, I'm happy to ask all of the questions that nobody is sure if they're good or not. Just send them to me only and I'll ask for you without attribution. So to get started today, Jim, I think we're gonna let you take it away.
0:03:27.6 Jim Hines: Thank you very much, Christie, and thank you everybody for coming. We have a lot to talk about, and as Christie pointed out, thank you to the US Congress, which takes its lead from me and decided to put off resolving any budgetary or tax matters until after today's talk. So I'd like to talk about government finance. And we can start with the question, is government finance a problem? I think everybody agrees that it is. It's not really a complicated problem in that somebody has to pay for government. Now, people want what government provides, but they usually don't want themselves to pay for it because it's obviously costly and irksome to have to incur these costs. So until recently in talking about these matters, I think there was a shared expectation that the country needs tax revenues, and then we can talk about how best to get them. There is more controversy these days about the extent to which you really need to pay for government services currently. And I do want to start with the discussion of that and then move to how best to pay for the expenses that we have. So there's a... Oops. Okay. Really, the need to pay for government comes from the proposition that the economy cannot provide something that it doesn't have, and that ultimately is where they need to pay for government comes from.
0:05:22.9 JH: The US government, the federal government, has considerable expenditures. We pay for that with taxes and borrowing. These expenditures are projected to grow. Of course, we don't know for sure what the future will hold, but they are projected to grow in the future, and so are deficits. As a result, we will have to do a combination of things, and it can be any combination of these things. We have to maintain and increase tax collections, or we have to increase the level of borrowing, or we have to reduce expenditures. It's not complicated. This is just the elements of accounting. You have to do one of those three things.
0:06:11.0 JH: I will add quickly, and I think this is generally conceded by liberals and conservatives, that current deficit projections are unrealistically low, that is when we look at projections for the future, they embody very rosy assumptions, and in particular, often the way Congress drafts tax rules and spending rules, they involve automatic cuts of spending and/or automatic tax increases in the future to sort of cover the cost of what's going on going forward, but nobody really expects those cuts in spending or those automatic tax increases to happen.
0:06:55.7 JH: So as a result, when you look at projections, just keep in mind that from a deficit standpoint, they're clearly unrealistic, they're too optimistic. This is the last 50 years, this is from the Congressional Budget Office, other outfits have similar calculations. This is the last 50 years of federal government budget deficits and the stuff below zero is the deficit. As you can see, the line has been... And this is measured as a percentage of GDP. GDP is gross domestic product, that's total national income. As you can see, almost all of the graph is below zero, meaning that the government has run deficit since 1971, they ran a small surplus in 1970, by the way. There was a... The only time when we haven't run deficits was right at the end of the Clinton Administration, the late 1990s, second half of the 1990s, when basically a combination of tax increases and economic growth produced federal surpluses. But there have been big deficits and in particular, recently, you can see on this picture that there are two big downward blips, we're actually living in the second of those two blips right now. The first one's from the crash of...
0:08:23.1 JH: The aftermath of the crash of 2008, when the US government basically bailed out the economy and did so with tax cuts and spending increases, and that's where you get the downward blip there. The other... Some of the tax cuts frankly are automatic because when the economy does badly, the government collects less revenue, and then you can see the pandemic around 2021, of course, and you have massive government spending programs to try to combat the consequences of the pandemic. And so that's what you get, that's where that big downward blip is. And you can see the dotted line, this is as of the summer, that dotted line, but the projections going forward are that the government will not be running these massive deficits, like we're currently doing, but that we will have significant deficits. It's just that it won't be quite like what we're currently doing. What we're currently doing, just to be clear, is the government deficit is 15% of total national income, meaning the amount that the government has to borrow is 15% of the total amount that the economy produces, which is enormous and clearly unsustainable. It's not possible to have a budget like that for very long. You can for a short period of time, and that was the whole idea, to have the government step in, do some things to help out and then stop doing those things because they...
0:10:01.4 JH: The only way to continue doing that would be to have a tax increase to actually pay for all of that, and we didn't do that. Okay, if you look at the... Again, this is the history of the last 50 years, and you can see... And this is, again, from the Congressional Budget Office. And you can see where the deficits are coming from and you can kind of see the time pattern as well. So there's a chronic gap between government expenditures, which average about 20% or 21% of national income and government revenues, which average between 17% and 18% of national income. They have to be equal for you not to be accumulating debt. The difference is made up for with borrowing. And so this is the source of government borrowing for the last 50 years. One of the things to note is, and again, if you look at the timeline there on the bottom, is you've got the revenues that go down when the economy does poorly, and that would be around the crash of 2008, and again, during the pandemic, and you have the outlays that go up.
0:11:14.5 JH: Again, the most dramatic cases on this picture are in the crash of 2008 and the pandemic, but that's not the only time. There was a recession around 1991, 1992, and you can see the outlays kinda went up then, there was a big recession in the early 1980s, and you see the outlay is going up then as well, and that's because a certain amount of government spending kind of automatically goes up when the economy does badly because the government is stepping in to help people out, but it's expensive. Okay. By historic standards, at this point, now we're in 2021, US governments accumulated a lot of debt. The current government debt-to-GDP ratio is about... Is at its historic high for the United States. It's about the same, almost exactly the same as where we were right at the end of World War II. And in World War II, the government borrowed massively to pay for the war, in addition to having tax increases.
0:12:21.1 JH: But there's a question, "Can you persist with debt-to-GDP ratio of this size? Or would you have to pay it all... Start to pay it down as we have in the past, as we did after World War II, for example? Or could you increase the amount of debt?" These are good and interesting questions, I think. We could spend many hours on them and I have a suspicion that they will come up in the question and answer, but I'm, for the moment, going to proceed under the assumption that the government cannot just borrow its way out of its spending... Out of its revenue needs, that there's no alternative to actually having taxes to finance expenditures. And I think realistically, that's true, meaning... Heaven knows the US Congress has demonstrated over and again how willing it is to spend when it doesn't have taxes to pay for all of the spending, but I don't think that Congress will go in the direction of a massive increase in federal debt.
0:13:37.3 JH: And so then the question is, where are we gonna get the money? Here's the federal debt, by the way. As you can see... And this is over the last 70 years, and this is measured as a fraction of GDP. And as you can see, we're at a little bit over 100% right at the moment, which was the same as we were right at the end of World War II. After World War II, as you can see, this federal debt went way down as a fraction of GDP, and the reason was the country paid it off. We had higher taxes back then and they used the taxes in part to pay down the federal debt from World War II. And as you can see, it's kind of gone up and down, and it went down, for example, at the end... In the second half of the 1990s when there were...
0:14:27.7 JH: The federal government was running surpluses. But it has gone up quite a bit recently, quite a bit in the last 15 years, and it's projected to go up further. And again, let me emphasize those projections are overly optimistic. They include things such as an assumption that Medicare spending will automatically fall when the Medicare trust fund is exhausted, which it will be just in a few years, and that's an unrealistic assumption. I might add, in my opinion, it's an undesirable thing, but whether it's desirable or not, if it were to happen, it's unrealistic. And so the deficits are going to get bigger. Okay. What should... What taxes do we need? And what will we do? Let's start with the taxes that the US government currently has. The primary sources of revenue for the US government are personal income taxes, which is... And that includes, by the way, the taxes on the income of Chapter S corporations and LLCs and partnerships and proprietorship, small business... So-called small businesses.
0:15:50.1 JH: So personal income taxes plus payroll taxes. The payroll taxes are your Social Security, disability insurance and Medicare taxes. Those are the primary sources of federal revenue currently. There definitely are other taxes. There's corporate income taxes, federal excise taxes, there's tariffs, but they don't add up to that much. And as I will mention again in a minute, the federal government does not have consumption taxes. We don't have a federal sales tax. We don't have a value-added tax... The primary source of revenue is the personal income tax and the payroll taxes. That's really different than other countries, because they rely much more on consumption taxes and social insurance taxes.
0:16:41.5 JH: So if you look at the percentage of GDP that the federal government raises with different taxes, this is the last 50 years of history. Again, this is from the Congressional Budget Office. Individual income taxes are a good chunk of the... It's the biggest single source of revenue. Payroll taxes are also a very large source of revenue. And for most people, those are the taxes that they see. Of course, if you get paid a wage or salary, a certain amount is paid by you in payroll taxes and your employer matches it. And individuals of course, have to pay income tax. Again, a lot of that's withheld automatically, but you're still paying the tax. There are other components of revenue including corporate taxes and excise taxes, but they kind of don't add up to that much. It actually never really have over the last 50 years. You have to go back a long time, or more than 50 years obviously, before corporate taxes or tariffs or excise taxes constituted a big fraction of the country's revenues. You contrast that with OECD countries. OECD countries are the wealthiest large countries in the world, about three dozen of them, and the highest income big countries are OECD countries. So that's the closest group you're gonna get to a comparison group to the United States.
0:18:21.6 JH: If you look at their sources of revenue, you'll notice that individual taxes are only a quarter of the total revenues. For the United States, that number is 49%. So the interesting thing is, if you compare America to other countries, America relies much more on the personal income tax, much more. Our social insurance taxes are kind of similar to those of other countries. The big difference is that America's consumption taxes are much smaller. Consumption taxes are things like sales taxes and excise taxes. And here, the real story is that other countries have value-added taxes, whereas the United States does not. And that is a huge source of revenue for them. Other countries rely much less on the income tax than America does, and we'll have a little more to say about that in a minute. There's good and bad in all of these choices, but it is a pronounced difference between the United States and other countries.
0:19:35.0 JH: So the United States famously does not have a value-added tax... Americans often are not even that familiar with what Value-Added Taxes are because we don't have one. A Value Added Tax is really a sales tax, it's a sales tax kind of done well, but it's a sales tax. That's what it is. And if you think sales tax, you have it about 99% right. Why doesn't America have a value-added tax.? The line that goes around is that we don't have one because liberals don't like it, because it is not progressive in the way that an income tax is, and conservatives don't like it, because it's too easy to raise money for government with a value-added tax... And people continue along these lines that we'll get a value-added tax. When conservatives realize it's regressive and liberals realize you can... It's easy to raise money for government with one of these things. But the fact is we don't have it currently.
0:20:30.1 JH: And it is not one of the current suite of options that anybody is really talking about in Washington. President Biden didn't propose it, and nobody is talking about a value-added tax. As a way of funding any current spending initiatives or paying off the debt. Realistically, if your revenue needs become dramatic enough, countries have no choice but to adopt a value-added tax... It does work, it does raise money for government, and the reason it raises money for government is that people... The economy ultimately does have to spend and when it spends, you can tax it with a value-added tax and that is why countries have it. In particular countries with a lot of revenue needs are much more likely than others to have high value-added taxes, because that is what pays for your revenue needs.
0:21:41.1 JH: It sorta makes sense, but it's worth thinking a little bit about this, which is value-added taxes, again, are like sales taxes and sales taxes, think about the Michigan 6% sales tax and ignore for the moment that it doesn't apply to absolutely everything you buy, but it applies to a lot of things. So we have a 6% sales tax in Michigan, it's the same tax rate whether you're rich or poor. Now, of course, the rich spend more than the poor, so they pay more tax, more of the 6%, but still, with an income tax, the tax rate goes up as your income rises. With a sales tax, the tax rate does not go up as your purchases increase. And so, it is not progressive in the way that an income tax is. The value-added tax alternative is not a progressive alternative. Progressive in the sense of having the rich pay a higher portion than the poor... A portion of their total income or expenditure than the poor.
0:22:50.9 JH: So, you just have to know what you're getting when you get a value-added tax. My own view is that one consequence of rising debt levels is that the more this happens, the more the country will be driven ultimately to a value-added tax and that people should just be aware of it. I do think it's a little too glib these days to say that we don't really need to pay for things and can borrow without thinking about what the borrowing will lead to ultimately down the road. And I'm quite convinced that if borrowing continues... I mean, there's no way borrowing could continue at the rate it's currently going, 'cause it's... We're in a crisis, and that's why we have so much debt being generated right now, but we will get a value-added tax as a result of unfunded spending binge, if that's what the country does. And when you get value-added tax, you will not be getting a progressive tax. So if the country just continues to borrow, that is what it leads to, and that is what it has led to in other countries. And so you have to ask yourself whether that's really the tax system that you want.
0:24:13.3 JH: I think, in my opinion, it isn't, but of course, people differ on this. Okay, let's think about income inequality and the tax system. Income and wealth are not equally distributed in the United States, and it seems like things have maybe gotten worse in modern times. And the United States has a progressive income tax system that imposes burdens based... And with the concept that you have a higher tax rate on the rich, because they have a greater ability to pay than lower income people do. This, you can think of as implicit redistribution, and the tax system could actually do quite a bit more of that. But my point is the way to do that is not by eliminating loopholes, but instead by having more tax loopholes than we currently do. This is not by the way a popular opinion. Up to now, the things I've been saying most, I think, tax economists agree with. Now we're getting into things that they should agree with but haven't yet.
0:25:23.1 JH: The tax system that we have has certain preferences that are often known as tax expenditures. People who don't like them sometimes call them loopholes. Loophole doesn't really have a great definition, so it's not a word that I use much, but it's a good way to criticize, implicitly criticize something that you don't like. There's a lot of partisan bickering over tax expenditures. Liberals point out that tax expenditures go mostly to the rich, which is absolutely correct. We'll look at some numbers in a minute, but prior to the 2018, the tax change introduced during the Trump administration, about a third of taxpayers itemized their deductions, and the higher income people were a lot more likely to itemize their deductions. And as a result, got the tax advantage offered in the tax code for certain things, such as mortgage interest deductions and state and local taxes.
0:26:28.9 JH: Liberals don't like the fact that these deductions, or loopholes if you wanna call them that, go to high-income people. Conservatives don't like these tax deductions either, or that both sides say they don't like them. Why don't Conservatives like them? Conservatives don't like them, because it kinda smacks off social engineer, that is the state and local deduction, for example, is a more favorable tax provision if you live in a high-tax state, like New Jersey, or California, than if you live in a low-tax state like Wyoming. And so the state and local tax deduction encourages state and local government spending, and it rewards high-tax states with a deduction, compared to not having that deduction. Conservatives don't like that. That is indeed part of why the 2017 tax legislation limited the ability to claim that deduction. Did not eliminate the deduction but capped it.
0:27:39.4 JH: To hear them talk, neither Liberals nor Conservatives like these tax expenditures. They don't like loopholes. Liberals are gonna pay for government by getting rid of loopholes. Conservatives are gonna get government out of your business by stopping this monkeying around with the tax system and no longer having political preferences expressed through favorable tax treatment. Neither side wants these things, they say, yet interestingly, we have lots of them, and we have for a long time under Conservative governments, under Liberal governments, it just keeps happening. Why is that? And again, here's some evidence for you. This is... The best data that we've got is till pre-2018, I'm afraid, but you can see that these are itemized deductions by taxpayer category... Category of taxpayer income. And as you can see, no surprise, the deductions go mostly to higher income taxpayers.
0:28:56.6 JH: The really big deductions are the interest paid deduction, which is mortgage interest on your owner-occupied house, the contributions deduction, which is for charitable contributions, and the taxes paid deduction, which is state and local income and property taxes. And anyway, those are the big items, and they tend to be a lot bigger for high-income people, because, no surprise, they have a lot more mortgage interest, they pay a lot more state and local tax, and they do more charitable contributions too, 'cause they got more income, and they do more of everything. Are there many of these tax expenditures? Yes. There's a lot of controversy about what counts as a tax expenditure, and I can talk at some length about that, as can a lot of people, but they add up to a lot of money, if you add them together, which you're not really supposed to do but people often do.
0:29:50.5 JH: So you will get editorials about once a year in the New York Times, for example, we'll have an editorial saying their $1.4 Trillion a year is lost through loopholes. This is what they're referring to, is the state and local tax deduction, the charitable contribution deduction and all of these other things. It's not quite true that if you eliminated all of them, you could cut all tax rates in half, but there's no doubt they add up to a lot. Where do they go? It's almost all... In terms of dollar amounts, it's almost all on the individual tax, which is not surprising, because the individual tax is most of the tax collections. There are corporate tax expenditures, but they don't add up to anything close to what the individual side does. And if you take, post the 2017 tax bill, which introduced a lot of changes, the three largest categories are... The biggest one always is the exclusion of employer-sponsored health insurance. Again, there's some controversy about the exact magnitude of this, but everybody agrees it is the biggest single loophole or tax expenditure.
0:31:15.4 JH: What is this? This is, if you have a job and you have health insurance through your employer, whatever portion of the compensation... Let's say that your employer sponsors a plan and there's a subsidized health insurance that you can... As a condition of your employment you're allowed to have. Then the subsidy portion of it is not treated as taxable income to you. That's what this big number is. What does that do? It does two things. It means that employees don't have to pay tax on that portion of their compensation. And so people who get this health insurance, it's a bigger benefit to them than it would be if this were taxed, like your wage and salary income is. So that's huge. The other thing it does, and this is part of the criticism, is that it encourages companies to structure compensation that way, because when you take a job you get the benefit of... They can give you more health insurance and maybe less wage and salary and it might be worth it to you. And in particular, on an after tax basis, it starts to look really attractive, because it's not subject to tax.
0:32:33.5 CB: Professor Hines, can we let Jeremy ask... Interrupt you?
0:32:36.8 JH: Sure.
0:32:37.9 Jeremy: Yeah. Sorry Jim, can I just clarify? This graph we're looking at here, is this corporate tax expenditures?
0:32:43.7 JH: No. No, this is individual.
0:32:49.1 Jeremy: So how does this fit into your previous graph that showed that mortgage interest and charitable contributions were the primary sources of the individual tax [0:32:58.8] ____?
0:32:58.9 JH: Sorry, I wasn't crystal clear on it. That was itemized deductions and these are... Mortgage interest and charitable contributions were the big itemized deductions, which is only a component of this.
0:33:08.2 Jeremy: Got it.
0:33:13.8 JH: So technically... So for example, the reduced tax rate on dividends and long-term capital gains, it used to be a deduction and now is just a reduced rate. So it's a little bit how you define these things. But the sorta economic point is, these are the biggest ticket items, but there are other ticket items as well. The biggest one always is this exclusion of health insurance. The next biggest is the retirement-related stuff, and then that's followed pretty closely by the reduced rates on dividends and long-term capital gains. The retirement stuff is... There's benefits of retirement plans, again, if your employer has a plan where you work on the job and they make a defined contribution, like a 401K or 403B or for that matter, if you have a defined benefit plan. Anyway, a retirement plan through your job, you're not taxed currently on the benefits that you accrue by working, even though it's kind of... You are sorta getting compensated because you're accruing these retirement benefits, but you don't take them until you actually retire, and we don't tax them until you retire. And so that's a tax benefit to you and actually it adds up to a lot of money.
0:34:47.6 JH: The third piece on here is the reduced tax rate on capital gains and dividends, which are for shareholders, and they're subject to a maximum 20% rate currently. Congress is considering legislation that would increase that, although heaven knows, you need to go hour to hour now with Congress to know where that's gonna go. But currently, there is a significantly reduced rate on that. If you... Again, there's some controversy about how to categorize some of these things, but you'll get some idea of what the big ticket items are here. This is billions of dollars per year and these are JCT estimates, Joint Committee on Taxation estimates. And there's a lot of these things, these loopholes, these deductions.
0:35:41.4 CB: So this is money that is not being... The dollars not collected?
0:35:49.9 JH: That is correct.
0:35:50.0 CB: Because of this... Okay.
0:35:50.6 JH: That's correct. So an easy one is there's $73.1 Billion of earned income credit, so that means that people got earned income tax credits of $73.1 Billion a year in 2018. There is... The tax benefits for defined benefit plans is $109 Billion, and what that says is that if we didn't exclude your defined... The defined benefit plans are things like, oh, if you work for 20 years, then you get half your salary kinda thing. If we didn't exclude that, you would have to be taxed now on the retirement benefits that you accrue now, even though you're not gonna retire for another 10 years. And so that's how much we give up by not taxing them currently, and that's what that number is.
0:36:49.1 JH: Okay. Who benefits from these tax expenditures, from this failure to impose a more comprehensive income tax? And the answer is high income people is who benefits. The liberal critique is certainly correct. You know, I will quickly add that high income people also pay most of the taxes, and part of the reason why they're getting most of the benefit of these tax loopholes, tax deductions, is that they also... They pay most of the taxes. And so even if the loopholes were kinda evenly distributed per dollar of what you're paying, it would come out about the same in terms of the distribution as what we currently have. I mean, it's not exactly the same, and I think it is a fair critique that these loopholes, these deductions go heavily toward high income people.
0:37:52.1 JH: What are the advantages of eliminating these tax expenditures, these loopholes? Of course, a lot of the advocates of this say, well, we could get more revenue, and that's absolutely correct if nothing else changes, and another attribute is that you would reduce the distortions that may be attributable to some activities getting favorable treatment and thereby encouraging... You know, over encouraging people to do that kinda thing and that it would produce a more equitable distribution of tax burdens, because the burden would fall primarily on the rich. It kinda makes you wonder whether...
0:38:31.0 JH: If all of this is true, why it hasn't happened, one possibility is that we have terrible politics and we can't do a lot of smart things, another possibility is maybe it's not quite as rosy as this makes it sound.
0:38:46.3 CB: Professor Stevenson, I bet you have an idea.
0:38:49.1 Professor Stevenson: Yeah, I just had to say that you didn't list my argument for why I hate tax expenditures, and it's because there's not a transparent accountability on our spending programs, I see them just like any kind of spending program and other spending programs have to be re-authorized year after year, discretionary spending programs evaluated and re-authorized and tax expenditures don't. So that was just one argument you skipped, so I thought I'd raise it for you.
0:39:23.0 JH: No, no. You're absolutely right that people sometimes raise that argument and... Yeah. Again, Betsy, we can go back and forth on this more. I think these days, the tax expenditures are getting a lot of scrutiny, and I sometimes wonder about our spending programs, whether they're getting the proper scrutiny, but you're right, it's a different way of doing things. The other piece I would add, there's nothing intrinsic about these expenditures being permanent in the code, or for that matter, the tax law being permanent. Congress chooses to have a tax... And it's a fairly recent choice, only done in the 1930s, to have a tax law that does not itself have to be re-enacted every year, we could, but they've chosen not to. And they could do the opposite with the spending, they could make the spending more permanent too if they wanted to, but they don't want to and there are reasons for that. But you're right, that is one of the arguments that is sometimes advanced. How should we think about equity? Should the tax system provide differentiation like a child tax credit? You take two families, one has children, the other doesn't, they both have the same pre-tax income, and the question is, should they pay the same taxes?
0:40:50.7 JH: There are coherent arguments on both sides of this question. I can tell you where I come down is that they should not pay the same taxes, that we should adjust the tax system for families' ability to pay, and that includes the number of children. So I think a child tax credit is a great idea but... And that is one tax expenditure. No, they're not all of this ilk, but that is one. There's a huge variation. A lot of the tax expenditures have the effect of reducing the taxation of capital income, most business income and income from savings and investments. The challenge there is that capital taxes, like the tax on capital gains, is imposed on activities that are highly responsive to taxation, and if there were no kind of separate regime, no lower tax rate on that stuff, it would be very hard to have a top tax rate of, say 50% with no adjustment for capital gains, because the capital gains would basically disappear and then you'd get no revenue at all from trying to tax that stuff, and all you would get is economic distortion.
0:42:13.4 JH: I believe that the real function of many tax preferences, in fact, most tax preferences is to permit the tax system to have higher rates. One of the critiques of... When people critique these tax expenditures, these loopholes for the benefits going to the rich, they're right, the benefits do go to the rich, the question is what we make of that. Where a lot of the world has gone is to say, "Oh well, therefore we should get rid of the loopholes, because the rich are not being currently taxed at the rate that they should be, and the way to do it is to get rid of the loopholes." I share the view that the rich are not being taxed at the rate that they should be, but I say keep the loopholes and raise the rates on the rich because they're getting the loopholes, and since they're getting the loopholes, it'll be easier to raise the rates than if not. If you do that, that actually leads to a better tax system than you would get by getting rid of the loopholes. I could go into the mortgage interest deduction, but I will... Which is often the most criticized of the loopholes.
0:43:31.6 JH: I will summarize it this way, the reason to have a mortgage interest deduction is because it allows you to have higher tax rates, what you need to do is follow through with the higher tax rates. What if we eliminated all the loopholes, all the tax expenditures? I think you'd get something like a flat tax. And really, when people criticize the system that we have with all of these credits and deductions, implicitly, I believe you're criticizing a progressive tax system. If you want a progressive tax system, then you have to have these loopholes and deductions. It's a totally coherent argument to say, "I don't want a progressive tax system," and again, we can have an argument about that. It's coherent to say, "No, I want a flat tax, a dollar is a dollar and every dollar should be taxed the same." And if you don't feel that way, if you think the tax burdens should be adjusted for ability to pay, and that that means much higher tax rates on high income people, I think inevitably that pushes you to a highly differentiated system with favorable tax treatment of capital gains, but less favorable tax treatment of other stuff and plenty of other credits and deductions.
0:44:54.9 JH: How do taxpayers feel? Taxpayers say they want the system to be simple, but actually most of the tax breaks that are out there are quite popular. I think what has happened is the government has responded to what people in fact want, and that is what has produced the system that we have. My view is we should do more of it, that is, we should expand, if anything, the deductions and credits. I would completely un-cap the state and local tax deduction. I think that was a terrible mistake in the 2017 bill. I hope Congress takes away the $10,000 cap, but I would raise the rates at the same time. Here's how you should get the money that you need, raise the rates. You can raise them at the top, you also need to raise them, not at the tippy top, but for people $100,000 to $400,000 of income as well, because we need money, and the way to get it is with higher rates.
0:46:06.7 JH: Where does it leave us? I think there are proposals to finance government with getting rid of these loopholes. I think they're a mistake. And my worry is that if we're not smart about what we do with taxes, we will be pressed, without even knowing that it's happening, into a situation where you have to adopt flat-rate type taxes like social insurance taxes and value-added taxes, and those, folks, are not progressive. With an income tax you actually have a chance of having a progressive system, but you have to do it smartly. Thank you.
0:46:48.2 CB: Okay, he's thrown it down, incited controversy. Before we start asking questions, can we all have a moment to acknowledge Jim Hines Turner video, do a little applause or something.
0:47:02.1 CB: Thank you for bringing this to us, this provoking argument. Who wants to start with questions? Okay, go ahead, Jeremy.
0:47:17.0 Jeremy: So I'm curious, the politics of this, Jim, and how it affects people and how that may affect the potential for adoption. I think one of the trade-offs is people see higher rates and they can intuitively feel how that's gonna affect them when they sit down to do their taxes, but when you're talking about deductions and expenditures, it requires more complicated mental math and it may be less obvious how an individual's tax burden will be affected.
0:47:51.0 Jeremy: So I guess I'm just skeptical about the argument of, "Oh, we should adopt higher rates and more expenditures," because I feel like that's unlikely to be widely acceptable. People are gonna only see the higher rates and just really resistant. So how do you sell this idea if people perceive it as potentially increasing their own tax burden?
0:48:23.8 JH: It's a great question. Again, there is a certain zero sum aspect to all of this in that it can't be that any one plan causes everyone to pay more because it's sort of a closed system so... But politically, how does this work? Look, politically, some things that are most attractive to politicians and to voters are the tax breaks, are things like the charitable contribution deduction, or the state and local tax deduction. And some of them I think are easy sells. That is, I wanna bring back... For example, Congress could say, "Well, we're going to reinstate a complete state and local tax deduction, but pay for it with higher rates." Will they actually do that? We'll see.
0:49:19.8 JH: Look, I will say it is hard. If a politician campaigns on a promise that no one with an income under $400,000 will pay any more tax, you've tightly constrained what you can possibly do and you kinda put yourself into an impossible box that way. And so that's kind of the situation that we're in right at the moment. So, look, I completely agree. Somebody runs for office, they take office, and the first thing they do is they increase the top tax rate in America to 55%, and your opponent says, "You're a big tax jerk because, look at the top tax rate, you went up to 55%."
0:50:04.1 JH: I think the top tax rate should be 55%, by the way, but I get that that's hard. The response can be, "Yeah, I'm trying to address our long-run funding needs, and because I'm here, Medicare Part D is actually gonna get some funding," which is true. Unfortunately, there's kinda been a conspiracy of silence by both Republicans and Democrats about government finance going forward, where nobody wants to acknowledge the Social Security and Medicare funding shortfalls and kind of will continue not to acknowledge them until, I assume, the crisis hits, but it's not a great way to run things. But that's what I would hope they would do.
0:50:56.7 CB: Chukata?
0:51:01.0 Chukata: Hi, Jim. Thanks for the talk. There's sort of one question and one comment. You showed us that the tax incidence is very different within OECD in the US, but compared to many OECD countries, my impression is that they don't all have state taxes and local taxes as much, maybe I'm wrong. So once you took the state taxes into account, sales taxes imposed and real estate taxes, how does the distribution from the US look from the OECD? Is it as different as you portrayed it?
0:51:37.7 JH: Yeah, I didn't... I think it's a great question, and I wasn't clear when I presented it. No, it basically is as I portrayed it, some of the numbers I was talking about included the state and local taxes. In the United States, half of our money comes from income taxes and that... In the OECD, it's 24%. So that's really the biggest difference. That plus, it's true, States have sales taxes, like Michigan has 6% sales tax, but this is nothing like the average VAT rate around the world, so there really is a big difference. This sort of politics of the regret... People in Europe and Canada and other places understand that these value added taxes are not progressive. Their argument is, "Well, you can have a flat rate tax like that, and it funds progressive government expenditures, expenditures that to do a better job of helping out disadvantaged people," and that is totally one way to go, although it is more interventionist than what has been the practice in America.
0:52:46.5 Chukata: And the comment is... This is not necessarily a well thought out comment, but it's sort of in response to Jeremy's question, a high sales tax, and if you collect the revenue through that or value added tax or what have you, does make the tax code simpler for every individual, so there is a trade-off between inefficiency and simplicity too.
0:53:14.3 JH: You're absolutely right.
0:53:17.4 CB: Professor Cran. But unmute and start over, though.
0:53:26.8 Professor Cran: Okay, a couple of quick things. One, just on the last comment, the tax system is enormously complicated if you have a lot of money, it's actually pretty simple if you don't. And that's the case for you buy TurboTax, and it does an okay job... Anyhow, that's actually not the main point I wanna make, two other points. One. So Jim the problem you wanna solve is, so you're convinced that we don't raise enough money, so how do we raise more money, we're gonna actually... We're gonna have some kind of revenue chart, we haven't quite figured out what it is, just how tax and spend liberal we are today, but considerably more money. And then if you're gonna do that, you say, "Well actually, if we're gonna get more money in a reasonable way, that should involve raising the rates and we should be willing to sort of engage in bargains with the lobbyists, tax expenditure by tax expenditure in order to get an overall more effective system," but the thing that you need to believe is that there's political will or social will or whatever it might be, to actually believe that raising revenue a lot is an important thing to do, and as you have pointed out several times and from some several different angles, finding the people who will run for office to say that isn't so easy.
0:54:47.6 PC: Third point is the point that I like to make him that nobody makes any more, but I remember having this conversation with the likes of Herb Stein and Charlie Shultz back in the day, and certainly your namesake, Musgraves, state and local deduction, actually its history is that it supports Federalism, it allows different levels of government to be able to essentially tax and spend at their net rate instead of a gross one in a country where we actually believe that we are a confederation of sovereign states, that just makes a lot of sense in terms of political philosophy, and then we can get the economics right.
0:55:31.7 JH: I completely agree with you. And look, there are a lot of reasons why I think it was just a mistake to cap that state and local deduction. Yeah, nobody wants to pay the bills. I agree with that. I just wish that people thought about the consequences of that. It's simply not true that you cannot pay your bills forever, that cannot be true, and...
0:55:56.9 PC: I agree with that too.
0:55:58.8 JH: Once you acknowledge that, then what you're really doing is you're teeing up a different world going forward by not paying your bills today, and people should just think about what it is they're doing.
0:56:15.6 CB: Jen, do you wanna ask your question or you want me to ask for you? I'll ask for you, 'cause you're still on mute. Jen's wondering, why can't we get the payroll tax rate for Social Security and Medicare increased?
0:56:36.0 JH: Yeah, I would say try it and then you'll see why you can't. Yes, it is a little known fact that I was on the Social Security Technical Advisory Commission 31 years ago. I know, I was a child. And yeah, we knew there was a funding shortfall then, it has come to pass, and the last time the country addressed anything about Social Security was 1983 and back then... That's when they extended the retirement age, pushed it out, phased it out over two years, which is a benefit cut, that's what it is, it's a benefit cut. There's a big problem right now with the funding, and there are two ways to address it, you could have a tax increase or you could have a benefit cut, or you can do a combination of the two, but there's no fourth alternative, that's it. It's either you cut the benefits or you raise the taxes or you do some of both. That's it.
0:57:43.0 JH: And if the question is... Look, the conservatives wanna cut the benefits, they don't say, "I wanna cut the benefits," but that's... And the liberals wanna raise the taxes. I mean, not everybody, but pretty much. And so then where do you go on that? There are coherent arguments on both sides of this question. I have my own take, which may not be different from a lot of other people's, but here's what I do know, it's really hard to do, for the same reason that other big problems are hard to do, which is the cost is kinda distant and the pain of addressing the problem is immediate. So it is by far the easiest thing in the world, not only to kick the can down the road, but to deny that there is a problem, and it's just not true. It's not a problem, but that's why, the pain is immediate, the game comes later, but it's just, it's a bad way to run things.
0:58:51.5 CB: Okay, last question, I know we're at time. James is wondering, do you have thoughts about the administrability of having more tax expenditures?
0:59:00.1 JH: Oh, it's a challenge. It's potentially a problem, and I think that limits how many you can have. So your point is... You asked it nicely, but your point is well taken, that we have to worry about administrability. No doubt about it. I do think that if you're gonna have a progressive income tax, it actually has to have these things. That is simply... You can't have a progressive system that is with rates that rise unless you've also got these tax expenditures, and so if you don't want the tax expenditures, you have to scale back on the progressivity of the system. That's the cost. But I agree, if you do have the tax expenditures, you've got problems of administration. I don't disagree.
0:59:53.3 CB: Perfect. Thanks very much for being here. Jim is writing a book. And so if you have burning questions that you didn't get a chance to ask, Kelly or Tracy, well, one of you drop his email into the chat, please. He would love to hear from you via email. Thank you to Tracy VanDusen and for Kelly O'Laughlin for handling the tech in the background today. Thank you again, Jim, for inciting controversy everywhere you go, this has been really fun. Thanks to all of you. Next month, our speaker will be Jerry Davis from the Ross School of Business, and the topic will be about taming...