In the light of the new Congressional panel on debt reduction, part of the agreement to end the shutdown, I thought it might be interesting to reflect on the revenue side of the federal budget’s equation. President Obama has repeatedly said that increased revenues were a necessary part of any debt reduction package:
WASHINGTON — Be skeptical. Be very, very skeptical.
That was the reaction from nearly all corners to the talk of convening yet another round of bipartisan negotiations to reduce the nation’s long-term debt. The idea has resurfaced as a way of resolving the standoff between President Obama and the Republican-controlled House over reopening the government and increasing its legal borrowing limit, perhaps for months or even just weeks.
But even if the current talks soon resolve the immediate impasse, which did not look likely on Saturday, any renewal of negotiations for a long-term fiscal plan will run into the same underlying problem that has doomed efforts for the past three years.
Republicans refuse to raise additional tax revenue, and until they do, Mr. Obama will not support even his own tentative proposals for reducing spending on fast-growing social benefit programs, chiefly Medicare. During a White House meeting with Senate Republicans on Friday, he reiterated that the two go hand in hand, according to people who were there.
The Republicans’ usual retort is that the president has already received additional revenues (in 2012) without accepting any cuts to entitlement spending.
I’d like to examine the question from a different angle. How could additional revenues be realized?
The most obvious answer is by increasing the tax rates on the highest income earners but that doesn’t really answer the question. The objective, presumably, is not just to raise marginal tax rates for the sake of increasing them but to increase effective revenues. Sadly, higher marginal tax rates, particularly on the highest income earners, have not historically been a reliable way of raising effective revenues. Consider this table from the Tax Policy Center of the Brookings Institution and the Urban Institute, reporting federal taxes as a percent of GDP from 1934 to the present. In only three years, 1944, 1945, and 2000, have federal revenues exceeded 20% of GDP.
Now, that’s not a physical law but it’s almost as good as one. It’s a political reality. Americans will accept the federal government’s extracting 20% of GDP from the economy at a time of national existential crisis or they’ll accept it briefly during a boom that looks like it will go on forever but it will be followed by a move to cut taxes. Is it possible that higher federal revenues would become politically acceptable? Anything is possible but the history of the last 80 years says it’s pretty darned unlikely.
The other obvious answer is via growth. Increased national income will increase federal revenues without increasing the proportion of GDP that goes to the federal government. Sadly, no one really knows how to do that. Paraphrasing my old economics prof, we know how to produce shortages but we don’t know how to produce growth.
As of this writing federal spending is hovering around 25% of GDP and expected to increase while revenues are around 17%. Growth is less than 2% per year. Can we all agree that persistent federal spending in excess of 25% of GDP with persistent federal revenues plus growth at less than 20% of GDP constitutes a problem?
I do not believe that increasing the marginal tax rates on the highest income earners in the absence of robust growth in the economy will increase effective federal revenue, largely because, other than under the conditions I’ve outlined above, it never has. The more income is in the hands of the highest income earners the more difficult it becomes to extract from them.
If you really want reliable increased federal revenues, you really need to increase taxes on those in the bottom 90% of income earners rather than on those in the top brackets. That can be done most easily by increasing FICA. IMO that’s a perverse policy.
Another alternative would be some sort of a consumption tax—either a VAT or a national sales tax.
So, let’s return to my question. How can what President Obama is insisting on be accomplished? How can effective federal revenues as a percentage of GDP be increased?
Quantitative Easing. :>
Gray Shambler.
Sadly, higher marginal tax rates, particularly on the highest income earners, have not historically been a reliable way of raising effective revenues.
People of means, liberal entities like Buffet and Google, will stash excess proceeds into overseas accounts, shielding them from the very tax increases they support for others. While the very rich can exercise such circumvention options, people with less substance have two choices — continue to work for less, or work less to avoid the taxation trap. In both cases the law of diminishing returns comes into play, whereby taxation zeal will be countered by human nature’s inclination to rebel under what is considered unjust extraction of earnings —- ultimately shrinking revenues rather than increasing them.
The other obvious answer is via growth. Increased national income will increase federal revenues without increasing the proportion of GDP that goes to the federal government. Sadly, no one really knows how to do that.
How about lowering the corporate tax- the highest in the world? That has been suggested for years as a way to bring monies back into the country. How about having less onerous EPA regulations, which are handicapping businesses, left and right, especially the clean coal industry — or anything to do with energy production, other than associated with PC green energy. Does Keystone Pipeline Project ring a bell? How about lowering the capital gains tax, freeing up investment money? In fact the very obstacles government puts in the path of a free market are the instruments slowing economical growth. Red tape unleashing bureaucratic insanity has almost vanquished business expansion and entrepreneurial excitement/confidence to risk their personal capital, while under the erratic, unfriendly-to-business Obama Administration’s guidelines and rules.
A VAT is the obvious choice. Increasing the death tax is another. A wealth tax is the other possibility. A wealth tax would make it harder for wealthy who hide income to avoid paying. Increasing income tax rates on lower income groups to pre-Bush tax cuts would help also.
That said, eliminating tax exemptions and subsidies (health insurance, mortgages, charity, etc) is where we should go first.
Steve
This wouldn’t bring in a ton of money, but hearing Drew’s head explode would be sweet, IRS Wakes Up to Private Equity Scam.
I think that about half of the members of Congress are there to prevent a wealth tax from being enacted into law. Ted Kennedy used to be the Democratic point man on that. I don’t know who is now.
A VAT is the obvious choice. Increasing the death tax is another. A wealth tax is the other possibility. A wealth tax would make it harder for wealthy who hide income to avoid paying. Increasing income tax rates on lower income groups to pre-Bush tax cuts would help also.
Yeah Steve, if forcing people works so well in growing an economy, what happened in Russia, and other places where this has been tried? You’re always trying to squeeze more dollars from producers, thinking they will oblige and graciously give it all away without any negativity or civil disobedience.
That said, eliminating tax exemptions and subsidies (health insurance, mortgages, charity, etc) is where we should go first.
You take the mortgage exemption off the table, and there goes the housing market. Do the same with charities, and they will suffer significantly less donations, causing more people to rely on the government. But, maybe that is the intention.
Everything you do to twist more money out of people will have a counter reaction that does not necessarily comply with what a social progressive’s computer model might say.
IMO, peak performances are created by voluntary action, not government mandates. If you stop using force, and instead apply incentives, business will come. It’s like that old baseball story about, if you build a field people will come. Well, if you have a field with weeds, stones, scorpions, and no lighting — analogous to excessive government disincentives — people will stay away in droves.
You do bring up a good point, though, one that I should have mentioned in the post. Reducing tax expenditures is one of the strategies that could be used.
The Grands Mamous of tax expenditures are, of course, employer contributions to employee healthcare insurance premiums, pension contributions, and the home mortgage interest deduction. About three quarters of the total. Everything else is small potatoes by comparison.
There are any number of other countries in which home mortgage interest is not deductible that have about the same rate of home ownership as we do so I don’t know that’s the case. However, I agree that it won’t help the housing market.
Nearly any approach to increasing revenues means that you can kiss a personal consumption expenditures-driven economic recovery goodbye. That’s why I think that the president’s insistence on the revenue side of the ledger is self-defeating.
Megan McArdle’s Bloomberg piece, Fight Over Default Is A Fight Over New Normal, has some provocative insights in it. She concludes by saying:
That is the growing conundrum, by-passing ideology, and putting it smack onto the track of pragmatism, mirroring Margaret Thatcher’s earlier words, ““The problem with socialism is that you eventually run out of other people’s money.â€
“That’s why I think that the president’s insistence on the revenue side of the ledger is self-defeating.”
Well, as I’ve said before, I really, really doubt you’d get any serious entitlement reform with increasing taxes…and not on the 90%.
Which is why the emphasis should be on saving Social Security and Medicare (while coincidentally trimming them) rather than on the more abstract “entitlement reform”.
Obama’s for chained CPI, much to the consternation of a lot of the party. But Medicare’s really the driver, right? If this paper cited by Tyler Cowen is accurate, much, much more of a driver than we’ve thought: How Medicare influences private payment systems.
I’m not in any position to opine about how one would go about “fixing” Medicare. Older folks get sick, they get frightened, and they vote. And I read a while back that one of the coming crises in eldercare is the growth in the elderly population of people with dementia. The care of those elders is going to fall most heavily on the families. (From my family’s experience, I can tell you that caring for someone with dementia is one of the hardest things there is. “Stressful” doesn’t even begin to capture it.) And those family members vote, too.
@sam, “old” is a large constituency with many friends and family, and with many aiming to join some day. But it looks like the dementia rate is dropping sharply; I don’t know if we know why, but I suspect environmental factors and improved mental health.
@sam
I only read Tyler Cowen’s synopsis of the paper.
I am not sure why this surprises the “experts”, but even when they are continually wrong, they continue to be considered experts. It is common sense, and it is what I have been getting at for some time. It is no different than the housing problem or the coming student loan problem.
Pouring money into a sector creates increased demand, and unless the supply increases proportionately, prices will increase. Attempts to fix the problem with more money only increase the problem.
This is not only a government problem, but the private sector has some limiting factors. Of course, this is assuming that the government does not bailout the private entities.
Both parties have been completely disingenuous about revenues and deficits for a long time now. GOP pretend they would be able to cut spending if not for the Dems, and Dems pretend they’d be able to fiz everything and “pay as they go” if only the GOP wouldn’t stand in the way of raising taxes on the wealthy.
When I see people acting like that, I can only assume that either no one knows what the hell to do or they are more interested in their self interest than in solving the problems….or, more likely both reasons apply.
@Tasty
“Pouring money into a sector creates increased demand, and unless the supply increases proportionately, prices will increase. Attempts to fix the problem with more money only increase the problem.”
Actually, the synopsis is somewhat misleading (although I sympathize with your reading as referring to price increases. It’s the natural reading, I think.)
The synopsis says:
“On average, a $1 change in Medicare’s relative payments results in a $1.30 change in private payments.”
It’s understandable to read that as saying a $1 increase in Medicare payments results in $1.30 increase in private payments, but the paper itself says:
That was offered just in the interests of clarification. It’s not meant to deny the truth of your fundamental point. (In fact, it no doubt supports your point.)
My modest proposal: Let’s sell the south to southerners. I don’t know what we should charge, a couple trillion at least. We bank that and then the real savings start to roll in, because we’d no longer be carrying places like Alabama and Georgia as deadbeats on the federal tax rolls.
Or we could stop jumping from “people have been stupid in the past” to the establishment of a law that, “people will remain stupid forever.” If we spend 25% of GDP we need to tax something close to 25% of GDP. Throwing up our hands and accepting stupid behavior incentivizes stupidity.
That’s what we did here in California. We stopped paying attention to Republicans, raised taxes, and now the budget’s balanced.
Note how well the paper supports my claim that Medicare functions as a price support.
Michael:
As long as you keep debts off-budget, as is the case in California and most other states, it’s relatively easy to maintain a balanced budget. Illinois has a balanced budget. That doesn’t mean that it’s being run on a fiscally sound basis.
sam
It hardly makes my head explode, except that it shows the ignorance and faulty frame of reference of commenters and general critics of an easy industry to take pot shots at. And even the ability to acknowledge that LP’s should be able to freely contract with GP’s.
Naked Capital gets several things wrong. (although at least they did not bring up that old canard about carried interest capgains treatment)
First, the management fee isn’t just a fee that goes to the general partners. It is used to run the firm – its pays the employees, the rent, light bill, audits costs of developing acquisition candidates etc and, generally, the broken deal costs when third party expenses are run up but a transaction not consummated, which can be significant. If there is anything that is left over it is a draw to the general partners. “Salary” if you will. Taxed, appropriately, at OI rates. Whether there is a lot or a little left over is highly situational.
Second, LP’s hate GP’s to get fee income. They prefer GP’s to make their money based on the performance of the portfolio (“carried interest’) which is variously 10-20% of the aggregated gain of all the companies over the return of capital to the LP’s capital account, plus a preferred return. So when a GP elects to defer a residual management fee it means the LP’s capital outlay is smaller and a smaller J-curve effect………….and it puts the GP’s income at greater risk, based upon investment performance. They could get nothing. Shorter: its the GP putting its money where your mouth is, and LP’s love that. Simply love it.
So hardly a “scam” it is exactly what the investors want, as opposed to, say, professors or internet commenters who don’t know what they are talking about. We have never used the technique because quite frankly we have never made big money on the draw. In fact I haven’t taken a draw in 4 years.
And speaking of talk is cheap, I will conclude as I always do on this subject. If its such easy money full of scams and the like I invite you in, everyone in fact, the water’s warm. Based on the depth of your comment, well, the lack thereof actually, you couldn’t do it if your life depended on it; you’d get chewed up like a mouse in a den of cats.
“As long as you keep debts off-budget, as is the case in California and most other states, it’s relatively easy to maintain a balanced budget.”
And of course the corollary – for example the supposed success of Social Security – as long as you keep raising taxes for funding its easy to ride the chariot and claim victory.
Dear Red:
Convince the IRS.
sam
Your inability to argue the point is noted. Do you even know what I said?
I saw you waving your arms.
Let’s just examine this point in your “argument”.
“First, the management fee isn’t just a fee that goes to the general partners. It is used to run the firm – its pays the employees, the rent, light bill, audits costs of developing acquisition candidates etc and, generally, the broken deal costs when third party expenses are run up but a transaction not consummated, which can be significant. ”
If that’s so, then explain why some PE firms do engage in the management fee waiver. If, in fact, the management fee is, as you assert, essential to the running of the firm, how then can some PE outfits waive it? How do they run the firm if they waive, according to you, the necessary wherewithal?
sam
So weak. I pity you. If you understood the business you would make alternative arguments. Ultra-large firms have the luxury of deferring management fees, even though the economic incentive position I stated still stands. Smaller firms, like ours, have no such luxuries. We make our money just like our investors – gains on investment.
Let me put this so your pea headed brain can understand it: would you prefer that your stock broker make money through commission for recommending you a security purchase? Or make money through the gain on that security, should it do so? Its that simple.
Do you even comprehend how petty and mind-numbingly stupid you sound in your “scam” commentary?? (Don’t answer, I know) This practice is everything an investor wants……………but being such a small person with nothing but invective for “rich guys” you must criticize.
Any wonder the nations investment posture is declining?
PS – sam
I don’t know what you do or did in your career. You may be absolutely fabulous at it. But finance and investment? Clueless idiot.
“If that’s so, then explain why some PE firms do engage in the management fee waiver. If, in fact, the management fee is, as you assert, essential to the running of the firm, how then can some PE outfits waive it? How do they run the firm if they waive, according to you, the necessary wherewithal?”
I have to admit I didn’t even read your entire comment as I’m a quick study. So then I saw this. sam, I’ve read enough of your comments that I know you are a smart guy. So why do you post something so stupid as the above? As I said, its the RESIDUAL that gets waived. The GP’s decline income, which is the residual. Second, big firms have certain scale advantages. Small firms (us) do not. But what do we do??? Optimize $50 – $250MM revenue firms. If you have a business bone in your body, and not just petty invective for rich guys, you should be waiving the flag for us. We are the GDP and employment drivers.
Serious question: Do you have any business acumen??
That said, eliminating tax exemptions and subsidies (health insurance, mortgages, charity, etc) is where we should go first.
Wonderful. Let’s make my HC spending even more expensive with what is in actuality a very regressive tax proposal. Greaat job, you poverty loving Dem you!
My modest proposal: Let’s sell the south to southerners.
The Democratic Wet Dream is to reduce the United States of America to San Francisco, parts of Marin County, Silicon Valley, Beverly Hills and a few related neighborhoods, select areas of Greater Boston, Manhattan below Harlem, the toney suburbs of NYC, and select areas of the Washington DC metro area, and then declare that clearly they’re superior because almost all the richest people live in their country. Yes, that must be because Democrats run everything so incredibly well.
But don’t notice that California has sky-rocketing poverty, or that the percentage of low income students in California is about the same as Florida’s percentage (54% vs. 56%). Nope, California is golden, because it is run entirely by Democrats, and everything works wonderfully there. And Florida is terrible, because it is run by Republicans, and nothing works here. Those 2% points make all the difference between Utopia and Hell.
Sorry, I forgot to link it up.
LINK
I just love how the progressives love regressive taxation and wealth redistribution from the bottom 90% to the top 10%. The greatest scam in politics is when the leaders of the looting class get to convince everyone, especially themselves, that they’re the ones with the big hearts, looking out for the little guys.
@Red
.
Right. The GP’s income declines…Sure. Except for the facts that 1) The GP gets to decide which of the items in the portfolio the waived fee portion (or all of it) get allocated to. Gee, do you think he or she would allocate the portion to anything other than the safest investment in the portfolio? Some risk there. And then 2) there’s that thing called “priority allocation” which allows the GP to get the first dollars of net gain in any fiscal period and “Net losses realized in prior accounting periods or in later ones have no impact on the priority allocations of net gains realized in the current quarter” (Polsky, Private Equity Management Fee Conversions, p.13). Sweet. And, of course, those dollars are now treated for tax purposes as captital gains. Sweeeeet. 3), And maybe most importantly, the GP has total control over the timing of asset movement in the portfolio, reevalution of the investments in the portfolio, and the timing of any elective waiver. Jesus, the risk….
And as for my question,
If that’s so, then explain why some PE firms do engage in the management fee waiver. If, in fact, the management fee is, as you assert, essential to the running of the firm, how then can some PE outfits waive it? How do they run the firm if they waive, according to you, the necessary wherewithal?
I should have been more precise. I apologize. You described an elective arrangement where the GP can say, well, not this period. But there is another arrangement, one in which the waiver is said to be hardwired into the very structure of the fund itself from the getgo. Here the GP has no elective option at all. The waiver is absolute. My question was really about this kind of arrangement. Now I know you guys are real smart. But you’re not clairvoyant. If the management fee supplies the money to turn the lights on and off, and a portion of the management fee is automatically waived, what happens if the operating expenses for a period are greater than the unwaived portion of the management fee? How is the shortfall made up? Well, there’s only two ways I can think of: 1) the parent company of the fund supplies the money or 2), the money is borrowed.
In 1), the parent company make a low-interest or no-interest loan to the fund (Maybe Bain could do this.). In 2), the money is borrowed from a bank. But here the interest on the loan is tax-deductible, right? Now, let me ask you if you don’t find some slightly untoward in the second scenario. A portion of the management fee is waived so as to garner capital gains tax treatment, but the resultant shortfall is covered by a loan whose interest is tax deductible, ie, the loan is subsidized by other taxpayers. So, in effect, taxpayers are subsidizing the machinery that allows the GP to garner what, in some cases, can be huge tax savings. Doesn’t that strike you as a little bit hinky?
I have an African Wisdom on Leadership calendar purchased at a free trade faire. Today’s nugget is an Ethiopian proverb:
With the arrival of a $17 trillion deficit, in a free-fall growth cycle following the debt ceiling rituals, I wonder how long it will take for all this inflated debt to go boom? The only variable not in question is who the dems will blame, which of course will be the party who dared to inject ideas meant to slow down spending, keeping deficits and debt boringly at bay. It’s a wonderful tribute, though, to the party of social progressives, as to how they keep their fiscally imbalanced Ponzi scheme alive, well, perfectly acceptable to a public suspended in spoon-fed doctrines — beliefs glued to a sky full of social entitlements for some, while the pockets of others are emptied, accompanied by promises that there always will be a pot of gold at the end of their redistribution-of- wealth rainbow .