James Sallee, University of Chicago and NBER
The Taxation of Fuel Economy
Policymakers have instituted a variety of fuel economy tax policies -- policies that tax or subsidize new vehicle purchases on the basis of fuel economy performance -- in the hopes of improving fleet fuel economy and reducing gasoline consumption. Sallee reviews existing policies and concludes that while they do work to improve vehicle fuel economy, the same goals could be achieved at a lower cost to society if policymakers instead directly taxed fuel. Even if policymakers prefer fuel economy taxation over fuel taxes for reasons other than efficiency, the evidence that he presents suggests several avenues for reform. In particular, fuel economy taxation is subject to several forms of gaming that could be eliminated through straightforward policy changes.
Katherine Baicker, Harvard University and NBER, and Jonathan Skinner, Dartmouth College and NBER
Health Care Spending Growth and the Future of U.S. Tax Rates
The fraction of GDP devoted to health care in the United States is the highest in the world and growing rapidly, with health care reform unlikely to slow that growth substantially in the intermediate term. While a recent set of economic studies suggests that such growth is not inefficient given the value of health spending, the fact that almost half of health care spending is publicly financed suggests that such increases could lead to a potentially very costly rise in tax rates. Baicker and Skinner use a life-cycle model of labor supply and saving to trace out the impact of rising health care spending on sustainable tax policy and on the distribution of the burden of paying for health care. The sharp increase in tax rates required to finance public spending, particularly in high income tax brackets, generate efficiency costs that could reduce GDP in 2060 by 12 percent, and may create a powerful brake on future health care spending growth. Consistent with these simulations, empirical evidence based on OECD data suggests that countries facing higher tax burdens in 1980 experienced slower health care spending growth in subsequent decades.
Gopi Shah Goda, Stanford University and NBER; John B. Shoven, Stanford University and NBER; and Sita Slavov, Occidental College
Implicit Taxes on Work from Social Security and Medicare
Implicit taxes are present in many government programs and can create substantial work disincentives. Traditionally, attention has focused on implicit taxes created when welfare benefits are phased out as one's income or wealth increases. However, the design of Social Security and Medicare also gives rise to implicit taxes, particularly for older workers. Social Security creates an implicit tax which is the payroll tax, minus the present value of the expected incremental benefits associated with the earnings. The payroll tax that funds the retirement portion of Social Security is 10.6 percent for workers of all ages, but the implicit tax varies considerably over a worker's career, because additional earnings translate non-linearly into additional retirement benefits. Goda, Shoven, and Slavov demonstrate that at the start of their careers workers experience lower implicit tax rates, because the increase in Social Security benefits that results from additional work offsets a relatively large fraction of the payroll tax. However, for workers who are closer to retirement, additional work translates into little or no additional benefit. In many cases, the payroll tax functions as a pure tax on work. The main implicit tax in Medicare lies in the Medicare-as-Secondary-Payer (MSP) policy, requiring that Medicare be a secondary payer for Medicare-eligible workers who work for an employer with a health plan and 20 or more employees. Medicare's expenses are effectively reduced then by the cost of health care for individuals with access to employer-sponsored health insurance. Thus, these individuals effectively forego the Medicare benefits that they would have received if they had not been working. A combination of policies can reduce average implicit tax rates on older workers by as much as 45 percent. These policies include: two modifications to the Social Security benefit calculation (using 40 years rather than 35 in calculating Social Security benefits, and distinguishing between workers with high earnings and short careers and low earnings and long careers); exempting workers who have achieved 40 years of covered employment from the Social Security and Medicare payroll tax; and repealing MSP. Given the relatively elastic labor supply of older workers, the efficiency gain from these policies could be considerable.
Ray C. Fair, Yale University
Possible Macroeconomic Consequences of Large Future Federal Government Deficits
Fair uses a multi-country macroeconometric model to analyze possible macroeconomic consequences of large future U.S. federal government deficits. His analysis has the advantage of accounting for the endogeneity of the deficit. In the baseline run, which assumes no large tax increases or spending cuts and no bad dollar and stock market shocks, the debt/GDP ratio rises substantially through 2020. The estimates from this run are in line with other estimates. Fair then runs various experiments off the baseline run. If the dollar depreciates, inflation increases but the effect on the debt/GDP ratio is modest. It does not appear that the United States can inflate its way out of its debt problem. If U.S. stock prices fall, this makes matters worse, since output is lower because of a negative wealth effect. Personal tax increases or transfer payment decreases of 3 percent of nominal GDP stabilize the debt/GDP ratio, at a cost of a real output loss of about 1.6 percent over the next decade. The Fed's ability to offset these losses is modest, according to the model. Introducing a national sales tax is more contractionary than increasing personal income taxes or decreasing transfer payments.
Martin S. Feldstein, Harvard University and NBER
Preventing a National Debt Explosion
Without changes in tax and spending rules, the national debt will rise from 62 percent of GDP now to more than 100 percent of GDP by the end of the decade and nearly twice that level within 25 years. Allowing the national debt to remain on that trajectory would pose serious risks for the economy and for our national security. Feldstein discusses those risks and then presents three strategies that, taken together, could reverse this trend and reduce the ratio of debt to GDP to less than 50 percent. The first strategy, labeled "stop digging," focuses on the current decade. It would reduce the Administration's proposed spending increases and tax reductions that would otherwise add $3.8 trillion to the national debt in 2020. The second strategy deals with the long-term costs of the Social Security, Medicare, and Medicaid programs. The real problem is not the future cost of these programs but the consequences of paying for them through taxation, since the projected increase of per capita GDP means that spending on everything else could rise very substantially, even if there were no reduction in the projected costs of these programs. Augmenting the tax financed benefits with investment based accounts would permit the higher future spending on health care and pensions with a relatively small increase in saving for such accounts. The third strategy focuses on "tax expenditures," the special features of the tax law that reduce revenue in order to achieve effects that might otherwise be done by explicit outlays. Most federal government non-defense spending, other than Social Security, Medicare, and Medicaid, is now done through tax expenditures rather than by direct cash outlays. These tax expenditures include deductions, credits, and exclusions that now result in an annual total revenue loss of about $1 trillion or more than 6 percent of GDP. Changes in such tax rules could permanently reduce future deficits without increasing marginal tax rates or reducing the rewards for saving, investment, and risk taking. Although the task of reducing the projected deficits is politically challenging, the historic record is actually encouraging. Feldstein concludes with a discussion of how the high debt to GDP ratio after World War II was reversed and how the last four presidents ended their terms with small primary deficits or primary budget surpluses.