Tax Policy and the Economy, Volume 29

By Jeffrey R. Brown

The papers in Volume 29 of Tax Policy and the Economy illustrate the depth and breadth of the taxation-related research by NBER research associates, both in terms of methodological approach and in terms of topics.  In the first paper, former NBER President Martin Feldstein estimates how much revenue the federal government could raise by limiting tax expenditures in various ways, such as capping deductions and exclusions. The second paper, by George Bulman and Caroline Hoxby, makes use of a substantial expansion in the availability of education tax credits in 2009 to study whether tax credits have a significant causal effect on college attendance and related outcomes. In the third paper, Casey Mulligan discusses how the Affordable Care Act (ACA) introduces or expands taxes on income and on full-time employment. In the fourth paper, Bradley Heim, Ithai Lurie, and Kosali Simon focus on the “young adult” provision of the ACA that allows young adults to be covered by their parents’ insurance policies. They find no meaningful effects of this provision on labor market outcomes.  The fifth paper, by Louis Kaplow, identifies some of the key conceptual challenges to analyzing social insurance policies, such as Social Security, in a context where shortsighted individuals fail to save adequately for their retirement. 

• Language: English
• Publisher: University of Chicago Press Journals
• Release date: Jan 20, 2016
• ISBN: 9780226338385

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Contents

Copyright

NBER Board of Directors

Relation of the Directors to the Work and Publications of the NBER

Acknowledgments

Introduction

Jeffrey R. Brown

Raising Revenue by Limiting Tax Expenditures

Martin Feldstein

The Returns to the Federal Tax Credits for Higher Education

George B. Bulman and Caroline M. Hoxby

The New Full-Time Employment Taxes

Casey B. Mulligan

The Impact of the Affordable Care Act Young Adult Provision on Labor Market Outcomes: Evidence from Tax Data

Bradley Heim, Ithai Lurie, and Kosali Simon

Government Policy and Labor Supply with Myopic or Targeted Savings Decisions

Louis Kaplow

Copyright

© 2015 by The University of Chicago. All rights reserved.

NBER Board of Directors

© 2015 by The University of Chicago. All rights reserved.

Relation of the Directors to the Work and Publications of the NBER

© 2015 by The University of Chicago. All rights reserved.

Acknowledgments

For 29 years, the National Bureau of Economic Research has sponsored the Tax Policy and Economy conference in Washington, DC. Each year, NBER researchers bring rigorous research to bear on policy-relevant questions and disseminate their results to the economic policy community by presenting at this conference and publishing in this volume. In return, Washington-based economists and other participants in the policy process provide valuable insights to the academic researchers, not only about the research itself, but also about the political economy environment in which policies are proposed, evaluated, and implemented.

This valuable interaction is made possible by the hard work of many individuals. Carl Beck, Lita Kimble, and especially Rob Shannon once again provided truly professional handling of all conference planning and logistics. They truly are the dream team for any conference organizer. Helena Fitzpatrick provided expert guidance through the publication process. And, of course, our NBER President Jim Poterba has been a strong supporter of this conference for more than two decades, and this year was no exception. I also thank the Lynde and Harry Bradley Foundation for its continued financial support.

I am especially grateful to the authors, whose research is the raison d’être for this conference. Collectively, the authors spend hundreds of hours producing research that helps to inform some of the most consequential policy discussions of our time. Equally important are the many individuals in the Washington policy community who actively participate in the conference with probing questions and comments, and who incorporate the research lessons into their important roles in the policy process.

A highlight of each year’s conference is the keynote speaker. This year, we were honored to have Jim Stock of Harvard University and the NBER, who had just recently returned to academia after serving on President Obama’s Council of Economic Advisers. His discussion focused on the sources and implications of long-term trends in GDP growth. A particularly remarkable feature of the data he shared is the decline in GDP growth rates (not just levels) following recessions, a finding that is important for understanding the slow recovery from the Great Recession as well as expectations about future growth. I am grateful that Jim was willing to accept our invitation for the second year in a row: his 2013 keynote was cancelled due to the untimely government shutdown and the limitations that this placed on government officials. His presentation, which was packed with substance and rigor, was well worth the wait.

© 2015 by the National Bureau of Economic Research. All rights reserved.

Introduction

Jeffrey R. Brown

University of Illinois, Urbana-Champaign and NBER

The 29th annual NBER Tax Policy and the Economy (TPE) conference was held on September 18, 2014, at the National Press Club in Washington, DC. This year’s conference featured a collection of papers that demonstrates the breadth of expertise of NBER researchers, both in terms of methodological approach and in terms of topics.

The first two papers in this volume focus on tax expenditures, a topic of recurring interest in the tax policy community and which has been the subject of prior TPE papers. Former NBER President Martin Feldstein presented estimates of how much revenue the federal government could raise by limiting tax expenditures in various ways. After discussing the substantial fiscal imbalance faced by the United States and the constraints on addressing it via reductions in discretionary spending or increased tax rates, he outlines the budgetary and economic effects of limiting tax expenditures. As a base case, Professor Feldstein examines a cap on deductions and exclusions that limits an individual’s tax reduction to 2% of adjusted gross income (AGI). Given varying marginal tax rates, this corresponds to a different amount fraction of income that can be deducted: for example, a taxpayer facing a 25% marginal rate would be limited to deductions and exclusions equal to 8% of AGI (0.25 *.08 = .02). In comparison, a taxpayer with a marginal rate of 40% would be limited to deductions and exclusions equal to 5% of AGI (0.4 *.05 = .02). Assuming this basic cap were applied to all itemized deductions except for charitable gifts, Professor Feldstein calculates that this cap would have raised $141 billion in 2013, or about 1% of gross domestic product (GDP). Over a ten-year budget window, he calculates that this would raise about $1.8 trillion of revenue. He also provides calculations indicating that such a cap would raise the progressivity of the individual income tax. The paper goes on to explore variations on this base case and to discuss the political economy of its implementation.

Among the many deductions and exclusions in the US tax code are tax credits for households that pay tuition and fees for higher education. The second paper in this volume, by George Bulman and Caroline Hoxby, makes use of a substantial expansion in the availability of education tax credits in 2009 to identify whether tax credits have a significant causal effect on college attendance and related outcomes. The authors discuss the two traditional justifications for large expenditures in this area: (1) the return on investment in human capital (such as through higher future earnings) and (2) the incidence of the credits being akin to a middle-class tax cut. To understand the empirical validity of these justifications, the authors use two statistical methods (regression kinks and simulated instruments) to identify causal effects on college attendance, the type of college attended, tuition paid, and the receipt of financial aid. The evidence strongly suggests that these tax credits have negligible causal effects on the outcomes of interest, a finding that is especially important in light of the fact that the cost of these programs in 2011 was approximately $25 billion. Although not the focus of this paper, the authors’ use of extremely rich micro tax data illustrates the valuable insights that come from the ability to study administrative data sets.

The next two chapters turn the focus from education to the interaction of health insurance and employment. Casey Mulligan discusses how the Affordable Care Act (ACA) introduces or expands taxes on income and on full-time employment. He calculates the tax wedge between the supply and demand of labor that is created by various provisions of the ACA and how this varies across household characteristics. By showing the effect of these wedges on household budget constraints, Professor Mulligan shows that the taxes on full-time work are large and economically significant, especially for young and less educated workers. He concludes that when the ACA is fully implemented, these taxes will amount to the equivalent of earnings from five hours of work each week. This work will undoubtedly be influential in guiding future empirical work assessing the longer-term labor supply consequences of the ACA.

The next paper in this volume is one of the first to explore the labor market consequences of the ACA empirically, and, to our knowledge, the very first to do so using tax data. Bradley Heim, Ithai Lurie, and Kosali Simon focus on the young adult provision of the ACA that allows young adults to be covered by their parents’ insurance policies. Using a panel of all US tax records from 2008–2012, the authors compare young adults whose parents have access to benefits to young adults without such access. They also compare young adults just under the age threshold to otherwise similar young adults just over the age threshold. The authors examine a comprehensive set of labor market outcomes, including employment status, educational enrollment, and wages. Despite the fact that other research has documented a large effect of the ACA on insurance coverage, these authors find no meaningful impact on labor market outcomes for the newly insured.

The last paper in this volume is a more conceptual treatment of labor supply decisions. Louis Kaplow explores how we should think about labor supply in the presence of myopic decision makers. He begins by noting that one of the leading justifications for social insurance systems, such as Social Security, is that myopic individuals may fail to save adequately on their own. If so, however, then this suggests that these same myopic individuals should not be modeled as perfectly foresighted optimizers when it comes to making labor supply or retirement decisions. Professor Kaplow identifies some of the key conceptual challenges to analyzing policy in this context, such as considering whether a myopic individual might view payroll taxes as a pure tax despite the future benefits to which they lead. He considers a range of cases, and finds that in most of the cases considered, savings policies do not operate like a pure tax. He also finds that labor supply can be increased, rather than decreased, in some models. His paper highlights the need for empirical work to determine how myopic preferences affect savings and labor supply decisions, and thus how these factors interact with public policy changes.

Taken together, these papers underscore why rigorous and careful economic analysis is essential to the design and analysis of public policies. Economic models, such as that of Mulligan and Kaplow in this volume, provide new insights into how individuals may react to policy changes. Careful empirical work using IRS data, including that of Bulman and Hoxby, and that of Heim, Lurie, and Simon, can often uncover surprising relations between policies and behavior that can and should guide future policy development. Still other research, such as that of Feldstein, can demonstrate the fiscal and distributional changes of potential policy reforms. The NBER looks forward to continuing to promote and disseminate rigorous and policy-relevant research in the future.

Endnote

For acknowledgments, sources of research support, and disclosure of the author’s material financial relationships, if any, please see http://www.nber.org/chapters/c13460.ack.

© 2015 by the National Bureau of Economic Research. All rights reserved.

978-0-226-33824-8/2015/2015-0001$10.00

Raising Revenue by Limiting Tax Expenditures

Martin Feldstein

Harvard University and NBER

Executive Summary

The prospect of very large future deficits and a rapidly increasing national debt is an important fiscal challenge for the United States. Limiting those deficits, and therefore the growth of the national debt, requires slowing the growth of the retirement and health programs. Additional tax revenue could contribute to that process. Limiting tax expenditures would raise revenue without increasing marginal tax rates. It would also be equivalent to reducing government spending now done as subsidies through the tax code for a wide range of household spending and income. An effective way of limiting tax expenditures would be a cap on the total tax reduction in tax liabilities that each individual can achieve by the use of deductions and exclusions.

The national debt of the United States is now 74% of GDP, double what it was a decade ago. The current annual deficit of about three percent means that the debt will grow at about the same pace as nominal gross domestic product (GDP), keeping the ratio of debt to GDP unchanged. Although that is likely to continue for the next several years, the Congressional Budget Office has recently warned us that the debt ratio will start rising again and will grow to very high levels during the CBO’s long-term forecast period (Congressional Budget Office 2014).

More specifically, under the extended baseline, the CBO projects that the debt to GDP ratio will rise during the next two decades to more than 100% of GDP. When the CBO drops some of the unrealistic assumptions that are required to be used in its baseline analysis, the forecasts in its alternative fiscal scenario show the debt rising to as much as 183% of GDP in 2039. The rising debt levels reflect the greater interest payments on the national debt and the increased cost of the middle-class health and retirement transfer programs. Limiting and reversing the rise in the national debt requires only relatively small decreases in annual deficit ratios. If real GDP grows at 2.5% and inflation is 2%, an annual deficit of 4.5% of GDP will cause the national debt to rise to 100% of GDP, but lowering the deficit to 2% of GDP will reverse the direction of the debt, causing it to decline to less than 50% of GDP.

There is little scope for reducing the deficit by cutting spending on the annually appropriated discretionary programs. While there is no doubt of substantial waste in many programs, total outlays for nondefense discretionary programs is now just 3.4% of GDP and is projected to decline to 2.5% of GDP in 2024. Similarly, the defense programs are projected to decline to just 2.7% of GDP in 2024. Therefore, reducing the annual deficit requires some combination of slower growth of the retiree and health programs and increases in tax revenue.

Tax rates have continued to rise in the years since the Tax Reform Act of 1986. That legislation reduced the top marginal tax rate to 28%. Since then the top personal income tax rate has increased to 40%. An additional tax increase on investment income was part of the Affordable Care Act, and the overall payroll tax on wage and salary income was increased when the old ceiling on income subject to the 2.9% Medicare tax was completely abolished.

It is a central tenet of public economics that raising marginal tax rates increases the distorting effects of the tax system and thus the deadweight loss to the economy.

Fortunately, it is possible to increase revenue without raising marginal tax rates. The key is to limit the reductions in tax revenue that result from the use of tax rules that substitute for direct government spending.

Some examples will illustrate the nature of these tax expenditures. If I buy a hybrid car or a solar panel for my house, the government rewards me with a subsidy payment. The subsidy does not take the form of a check from the government, but of a reduction in my tax liability. If I pay more in mortgage interest or in local property taxes, the government subsidizes my spending by allowing those expenses to be deducted in calculating my taxable income and therefore my tax liability.

According to the Joint Committee on Taxation, the tax expenditure subsidies in the personal income tax code reduces revenue this year by approximately $1.6 trillion (Joint Committee on Taxation 2014). Those tax rules (especially the exclusion of employer payments for health insurance) also reduce the income that is subject to the payroll tax, leading to an additional loss of government revenue.

Eliminating any of the tax expenditures or limiting their use would shrink the size of the annual deficits. Although the effect would show up on the revenue side of the government budget, that is just an accounting convention. In terms of real economic impact, limiting tax expenditures should be viewed as a reduction in government spending.

The ability to frame tax expenditures as either revenue increases or spending decreases should make limiting tax expenditures appeal to those Republicans who want to reduce government spending as well as to those Democrats who want to use additional revenue to help shrink fiscal deficits. Some of the revenue produced by limiting tax expenditures could also be used to reduce marginal tax rates.

Any attempt to limit a particular tax expenditure will be resisted by those who now benefit from it. That suggests that a comprehensive approach may be more politically feasible because no group of taxpayers will feel that they have been unfairly singled out. It also suggests that it would be politically difficult to eliminate completely any of the major tax expenditures. Instead, the analysis in this paper focuses on a method of limiting the extent to which each individual can benefit by using the full set of current tax expenditures.

The first section describes a potential basic cap on the benefit that individuals can receive from an extensive set of tax expenditures. Section II discusses several features of using such an overall cap. The third section examines several variations of the basic cap. Section IV considers two alternatives to the cap stated as a percentage of GDP: limiting the overall dollar amount of deductions and limiting the benefit of deductions and exclusions to the 28% marginal tax rate. There is a brief concluding section.

I. A Basic 2% Cap on Tax Expenditures

The tax expenditure cap that I have been studying would limit each individual’s ability to reduce his tax liabilities by the use of deductions and exclusions to a fixed percentage of that individual’s adjusted gross income (AGI). Note that the cap is on the reduction of tax liabilities and not on the amount of the deductions and exclusions.

For example, a tax expenditure cap of 2% of AGI implies that someone with a marginal tax rate of 25% can have deductions and exclusions totaling 8% of his AGI, whereas someone with a marginal rate of 40% would be limited to 5% of AGI.

To implement this cap, the taxpayer would calculate his taxable income in the usual way and find the corresponding marginal tax rate. He would then multiply his total deductions and other tax expenditures by this marginal tax rate. If the resulting amount is less than 2% of his AGI, there is nothing more to do. If the resulting amount exceeds 2% of his AGI, the excess amount is added to his tax obligation.

The basic cap that I have analyzed would apply to all itemized deductions except charitable gifts. Although it could also be applied to charitable gifts, there are both economic and political reasons that policymakers may wish