Charts of the day, CBO testimony edition

By Felix Salmon
September 14, 2011
Doug Elmendorf's presentation to the Joint Select Committee on Deficit Reduction.

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

Two charts jump out at me from Doug Elmendorf’s presentation to the Joint Select Committee on Deficit Reduction. The first is the sheer size of various loopholes in the tax code:

loopholes.jpg

If you want to make a serious dent in long-term deficit reduction, this is a good place to start. Everybody knows that Social Security and Medicare — pensions and healthcare — comprise a massive part of the government’s future spending. What’s less well known is that pensions and healthcare are also the two biggest tax expenditures in the tax code: the deductibility of healthcare premiums will cost the government about $650 billion over five years, with the deductibility of pension contributions running it a close second. That’s over a trillion dollars in lost revenue right there. Add in the mortgage-interest deduction and the lower rates on long-term capital gains, and you get to $2 trillion pretty quickly. Double that to get a ballpark ten-year figure.

This is something that proponents of private health insurance don’t often grok: that it’s heavily subsidized by the federal government already, due to its tax-exempt status. And it stands to reason that if the government is going to spend hundreds of billions of dollars a year subsidizing private health insurance, then it ought at the very least to get some kind of control over the healthcare industry in return. If you want to keep the system fully private, then fine, but don’t ask the government for massive subsidies at the same time.

As for the tax deductibility of pension contributions, Mark Miller wrote a great post on the subject in June, in which Teresa Ghilarducci makes a very strong point.

Ghilarducci argues that retirement saving wouldn’t decline if the deduction disappeared. “There’s no evidence that it increases saving; much of the academic literature shows that higher income people are simply moving investments they would have made anyway [in taxable accounts] to a tax-preferred account. And there are 25 million taxpayers in the bottom two quartiles who don’t take deductions, so they’re getting no subsidy at all from the federal government on their contributions.”

Everybody’s talking about the necessity of making hard choices: there are lot of hard choices here which could have an enormous effect on government revenues while at the same time simplifying the tax code and even maybe allowing a reduction of the headline rate of income tax. I’m in favor of taking a whack at all of the bars on this chart, with the exception of the EITC. Doing so would make the tax system more progressive, simpler, and more lucrative. Which is exactly what we need.

So, that’s one opportunity facing the deficit committee. But here’s something scarier:

unemployment.jpg

This is the official CBO unemployment projection, on which all of its economic forecasts are based. And it shows unemployment plunging to 5% after 2015. That’s considered the long-term unemployment rate, and I guess that 2015 is considered the long term, or something. In any case, it ain’t gonna happen — there’s absolutely no reason to believe that the economy will suddenly add an enormous number of jobs in four years’ time.

As a result, actual tax revenues are going to be lower than the CBO is projecting, since the CBO is anticipating revenues from millions of people who won’t in fact be employed. And government expenditures on unemployment insurance, Medicaid, and the like will be substantially higher than the CBO is projecting.

So when we get to work on the deficit, it’s important to remember that the problem is bigger than the official CBO numbers would have you believe. Partly because the CBO is assuming things like a 30% reduction in Medicare payments for physicians’ services after 2011, which simply isn’t going to happen. And partly because the CBO is being incredibly overoptimistic on the unemployment rate. So let’s get to work on reducing the size of those loopholes. It’s the only way we can credibly free up enough money to provide the stimulus the economy needs right now.

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
16 comments so far

Not sure I understand how you need to “take deductions” to get the benefit of the retirement savings tax break? 401k contributions taken out of your paycheck are excluded from your taxable income from the get-go (i.e. they aren’t subject to withholding on your paycheck and that money doesn’t show up on your W-2) so long as you stay within the limits. Contributions to IRA and various self-employed plans are above-the-line deductions on page one of the 1040. Am I missing something?

Posted by jfruh | Report as abusive

I consider myself a “proponent[] of private health insurance”, as opposed to what we have now. Certainly eliminating the subsidy would help. I wouldn’t expect a private market to somehow be cordoned off from the part of the economy that the government taxes, subsidizes, and regulates, or even for the government to do no taxing, subsidizing, or regulation of healthcare and health insurance directly — the government will always affect the market rules. Even with that acknowledgement, though, the market for, say, groceries, notwithstanding health inspections, FDA regulations, USDA rules and even subsidies, and so on, looks like a private market subject to regulations, whereas the health insurance market looks much more like a socialist market with various free-market elements grafted onto it.

Posted by dWj | Report as abusive

“There’s absolutely no reason to believe that the economy will suddenly add an enormous number of jobs in four years’ time.”

Actually, there is a good reason to believe so: housing starts are currently running far below their long-run sustainable rate, and 2014 or 2015 is a very reasonable time frame for them to rise quite dramatically as excess supply is absorbed. This won’t drop the unemployment rate to 5%, but it will start the virtuous cycle that typically pulls the country out of recession.

Posted by MitchW | Report as abusive

If my company’s demographics are representative of other large corporations, I think there will be a sizeable drop in the unemployment rate over the next 2 to 5 years – as baby boomers retire. Almost 20% of my department’s employees (including me) are planning on retiring between 2013 and 2016. And we’ll retire sooner if we get a decent package.

Posted by weneedchange | Report as abusive

These tax deductions are simply transfers or benefits to those already with jobs/house; they serve no purpose for the whole society. They actually distort efficient pricing.

We need to eliminate these tax deductions. Especially now. We need government spending/fiscal stimulus to resume the growth in our economy.

Posted by proton1 | Report as abusive

Great writeup. It’s amazing how much expenditures there are in the tax code, and how much distortionary impacts we get here. At a minimum, I could see good reason to phase some of these out (home mortgage interest is basically a debt/leverage promotion policy) for the upper brackets. The affluent would still get them, but only to the portion of their income that taxable at the 28% level, or 33% level. I wonder how the revenue would work out in those cases?

Posted by EconMaverick | Report as abusive

I keep getting confused by the notion of a long-term unemployement rate (5% you referred to). Since this chart uses the unemployment rate definition that excludes discouraged workers not looking for a job, etc., how is it that there should still be another 5% who should be unemployed? Who are these people?

Posted by junkcharts | Report as abusive

Who are the 5%? People in transition (between jobs, laid off, leaving or returning to school or the military).

People whose old job paid enough to cover the cost of child care, but now it doesn’t make sense for him to work too.

People who worked for a small business, the LARGE majority of which fail.

People who are trying to start a small business, but don’t have capital or access to it.

People who are injured and/or disabled, and got laid off because of it.

People who are pregnant, and got laid off because of it.

People who worked 90-hour weeks for so long they became physically and mentally exhausted, and got canned for being slackers.

Journalists and others who work in “industries in transition.” (The glories of “creative destruction,” which is rarely the first.)

Posted by klhoughton | Report as abusive

“Not sure I understand how you need to “take deductions” to get the benefit of the retirement savings tax break?”

There may well be 25 million people who don’t contribute to retirement accounts at all. I agree that Felix phrased it poorly, though.

“There’s no evidence that it increases saving; much of the academic literature shows that higher income people are simply moving investments they would have made anyway [in taxable accounts] to a tax-preferred account.”

A few thoughts on this point…
(1) The spending of working-class households is likely more sensitive to incentives than the spending of investor-class households. Don’t assume that conclusions based on the one group translate to the other group.

(2) Our total savings exceeded our mortgage balance in 2004, yet 3/4 was locked away in retirement accounts. Only recently has our mortgage balance dropped below our taxable savings. Remove the distinction between “retirement accounts” and “taxable accounts” and we likely would have paid off the mortgage a decade earlier. ESPECIALLY if you simultaneously strip the mortgage-interest deduction.

Definitely worth exploring the economic distortion of these tax policies, but it is also worth questioning whether the distortion might be desirable?

Posted by TFF | Report as abusive

klhoughton: are those people you listed counted in the 16% statistic not in the 9% statistic?

Posted by junkcharts | Report as abusive

Wow, you people get all those exemptions from tax? Over the five years they add up to two and a half trillion dollars! Take out the Bush era defence budget increases too and that’s close on five trillion dollars in five years. Deficit? What deficit! That could pay off the deficit and make a significant cut in income tax rates as well. Not only that, but by simplifying the tax code you cut the cost of tax collection, and reduce the size of government too.

As for the comment about socialism, Im sure that contributor is getting confused with communism. Socialism is like a wagon train where you all keep your own wagons and goods but work together to cross the mountains, leaving nobody behind; communism is where you all live in a hippy commune and never cross the mountains because you decide the first one across gets an unfair advantage over the others so nobody does anything. I suspect that poster’s idea of a free market economy is where the strongest cattle baron takes everything and shoots everyone else.

Posted by FifthDecade | Report as abusive

so over 1 year, that is 500billion. Lets take the fake 3 trillion figure for the war and we get another 430billion per year add it together and you are only another 500 billion more to match the DEFICIT – not the debt.

Posted by Danny_Black | Report as abusive

Also, Danny_Black, note that eliminating a tax deduction is very similar to a tax increase. The biggest difference is that eliminating deductions removes economic distortions while a tax increase creates them. (Separate from the question of whether the distortions are themselves positive or negative.)

It isn’t terribly insightful to observe that massive tax increases could in theory eliminate the deficit. Cut those big four and the federal income tax for my household would nearly double. And many lower-income households (e.g. $50k-$70k household incomes) would see a proportionately greater increase, since their present income tax bill is so low.

Posted by TFF | Report as abusive

Ignore the war cost label, look at the annual Defence Budget spending and see how it doubled during the Bush years when the public debt doubled in size from $5 trillion to $10 trillion. Granted it’s gone up 40% more since 2008, but Bush had no global financial crisis to fix – he just fancied an unnecessary war in Iraq (nothing to do with 911) and wanted tax cuts.

But of course, the US has never been anything other than a debtor Nation, ever since 1791 according to Wikipedia. Looks like an addiction from where I’m sitting.

Posted by FifthDecade | Report as abusive

These guys can’t seem to get through their heads what the experts tell them over and over: Take action now to reduce future deficits. Do not lower the deficit now.

Since the Republicans have ideological blinders on, they don’t know how to take this advice. And since the Democrats refuse to lead on this issue, we are in a bind.

These are the basic steps; things that reduce future deficits without hurting the recovery today.

1) Gradually raise the retirement age to 70.

2) Reduce the cost of living adjustment formula for Social Security. If the old formula would give 2% inflation, give 1.5%.

3) Offer to pay the college educations for all doctors and nurses that stay in the profession for ten years, to limit expected future shortages of these professionals.

4) Freeze defense and non-defense discretionary spending at today’s levels. Let inflation whittle away at these.

5) Help homeowners reduce their debt, by using Fannie & Freddie to buy mortgages and write them down 30% using printed money. This debt is what is keeping folks from spending.

6) Set a date certain for letting the Bush tax cuts expire on those earning over $100,000. Remove the cap on the payroll tax, which is at 106,800. This brings in revenue from wealthier folks, which has the bare minimum impact.

7) Attack offshoring, via tax and trade policies that do not reward companies for sending labor overseas and pocketing the wage differential. This has killed our jobs engine, which generated 2 million jobs the past decade vs. 20 million in each of the prior 3 decades. Our $650 billion goods trade deficit is 10-15 million jobs, nearly 2/3rds of our unemployment problem.

Posted by Farcaster | Report as abusive

“Offer to pay the college educations for all doctors and nurses that stay in the profession for ten years, to limit expected future shortages of these professionals.”

Are trained doctors leaving the profession? I know that many are reluctant to enter general practice, due to income disparities between the specialties, but I haven’t heard of any leaving for other fields.

And isn’t the supply constrained primarily by medical school acceptances? There are many more hopeful applicants than seats. Those denied admission may be weaker students, perhaps, but are still generally very bright people.

Posted by TFF | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/