issue: Tax

A Red Card for Airbus

Posted on by The Progressive Policy Institute

Referees often make costly mistakes, as we’ve seen in the World Cup. But the World Trade Organization (WTO), which umpires international commerce, got a big decision right yesterday. It handed the United States a thumping victory in a long-standing, high-stakes dispute with Europe over aircraft subsidies.

At issue were some $20 billion and below-market lending rates — known as “launch aid” – that several European governments had provided to aircraft manufacturer Airbus. The WTO deemed launch aid to be an illegal subsidy, upholding a September 2009 interim ruling.

The largess of European taxpayers was critical to Airbus’ development of several of the companies’ main commercial jets. Without such favorable financial assistance, the WTO’s ruling said, it “would not have been possible for Airbus to have launched all of these models, as originally designed and at the times it did.” In other words, without government subsidies, Airbus would have never have become the world’s number 2 player in the lucrative market for commercial airframes. U.S. Trade Representative Ron Kirk has said that the subsidies have done “great harm” to competing U.S. manufacturing firms, especially number 1 Boeing.

The ruling is welcome, not just for Boeing and American manufacturers but because it boosts the credibility of the rules-based global trading system, which lately has shown signs of fraying at the edges. If the rules aren’t enforced, trade will become a zero-sum game as countries resort to mercantilist and protectionist strategies to protect their economic interests. That in turn could bring global prosperity crashing down. The WTO’s decision is important too because it serves as a warning to other countries — China, Brazil, and Russia — who might or want to subsidize their own aircraft producers.

In an ironic twist, even the unions were on board in support of freer trade in the Airbus case. As Will Marshall and I wrote back in September (when the interim ruling was announced), “Although organized labor often has taken a skeptical if not hostile stance toward international trade, Boeing’s unions strongly backed the U.S. government’s decision to file the case in 2004. The unions realized that Boeing competitiveness was suffering and that only fair and enforceable trade rules would ensure it.”

The WTO has no mechanism for enforcing its rulings,  but rather provides the legal justification for the United States  to even the playing field. It would be best, of course, if Airbus and its European patrons bowed to the WTO’s judgment and end the illegal subsidies. It would be a tragic irony if Europe were to embrace an economic unilateralism even as President Obama has put the United States back on a course of multilateral cooperation. But if Europe won’t play by the rules, the United States has three options.

First, our government could levy tariffs on Airbus imports to the United States. Second, it could spread the pain by taxing other European imports. And third, Washington could subsidize aircraft production by U.S. firms.

The first is far and away the best choice — taxing Airbus limits the trade dispute to an isolated sector of the market, and avoids a broader trade war over other products. Government subsidies for U.S. firms are the least attractive option, because other companies in other sectors may lobby for money based on that precedent, further distorting trade.

I don’t expect Europe to just roll over and play dead. Though the EU hasn’t officially decided whether or not to appeal the ruling, and there is the possibility that some governments will just ignore the ruling and continue to subsidize production. That’s a big gamble of course, because it would just provoke more stringent U.S. tariffs on imports.

But for now, the good news is that the worlds’ trade ump is on the job, sending off those who break the rules.

Photo credit: Caribb’s Photostream

Ancient History

Posted on by The Progressive Policy Institute

Bruce Bartlett has a column up in today’s Fiscal Times that drills home just how far the Republican Party has veered from the center over the last few years. Bartlett recounts the story of the 1990 budget deal, which saw President George H.W. Bush reach across the aisle and strike a compromise with Democrats in an effort to shrink the deficit. The compromise on Bush’s end is, of course, now legendary: a violation of his “read my lips” pledge during the 1988 campaign that there would be no new taxes.

Working with Democratic majorities in both houses, the president knew that getting through measures on the spending side of the ledger would require some concessions on his part. Bartlett sums up the outcome of the budget negotiations:

Budget negotiations finally concluded in late September. The final deal cut spending by $324 billion over five years and raised revenues by $159 billion. The most politically toxic part of the deal, as far as congressional Republicans were concerned, involved an increase in the top statutory income tax rate to 31 percent from 28 percent, which had been established by the Tax Reform Act of 1986. The top rate had been 50 percent from 1981 to 1986 and 70 percent from 1965 to 1980.

More importantly, the deal contained powerful mechanisms for controlling future deficits. In particular, a strong pay-as-you-go (PAYGO) rule required that new spending or tax cuts had to be offset by spending cuts or tax increases. There were also caps on discretionary spending that were to be enforced by automatic spending cuts.

The conservative base, of course, went ballistic. Their opposition was reflected in the House of Representatives, where 163 Republicans voted against the budget, while only 10 voted for it. The Senate was a little better — half of Republicans approved the deal. These days, getting half of the Republican Senate caucus to go along with anything the Democratic majority pushes would be a minor miracle.

The consequences of Bush’s budget deal are well known. The violation of his tax pledge would prove to be a devastating weapon for political opponents in the 1992 campaign. But the economic consequences are less heralded. President Clinton deserves credit for bringing sanity and surpluses to the budget in the 1990s, but budget experts agree that his predecessor’s budget deal contributed to that achievement.

Bartlett quotes the GOP’s tax-cutting commissar, Grover Norquist, to underscore conservative suspicion of budget deals: “Budget deals where they actually restrain spending and raise taxes are unicorns.” Only spending cuts, Norquist argues, are permissible. The way the right is moving these days, we’re more likely to see a unicorn than a GOP leader going against party orthodoxy on taxes.

Photo credit: sdk

Follow the Leader

Posted on by The Progressive Policy Institute

Congress isn’t always the first place you look for intellectually honest discussion of America’s fiscal dilemmas. Neither party has clean hands, yet each points smudged fingers at the other. How refreshing then to hear Rep. Steny Hoyer (D-MD) uttering blunt truths rather than partisan cant about America’s exploding debts.

“Unfortunately, we can blame our long-term deficit on policies that are almost universally popular,” the House Majority Leader said yesterday at a forum hosted by Third Way. “We’re lying to ourselves and our children if we say we can maintain our current levels of entitlement spending, defense spending, and taxation without bankrupting the country,” he added.

Hoyer also wondered aloud about the wisdom of permanently extending any of the Bush tax cuts absent a serious plan for long-term deficit reduction. It’s a pertinent question for both Republican anti-tax zealots and President Obama.

Even as they excoriate Obama and the Democrats for ballooning the federal deficit, Republicans insist that all the tax cuts passed in 2001 and 2003 be extended. That would cost a cool $3 trillion over the next decade, but don’t expect the GOP to fill that gaping hole in the federal budget with spending cuts. As Hoyer pointed out, Republicans have run like scalded dogs from Rep. Paul Ryan’s “roadmap” to a balanced budget, which calls for deep cuts in Medicare and Social Security.

But President Obama is in a bind as well. He has set up a fiscal commission to come up with a plan after the midterm election to start unwinding America’s massive debts. Many economists believe such a plan is essential to boost investor and lender confidence in the soundness of the U.S. economy, and to reverse the enormous imbalances in world financial flows.

During the 2008 campaign, however, Obama promised to extend the Bush cuts for the “middle class,” which he defined as families earning less than $250,000 and individuals earning less than $200,000. That promise helped him deflect GOP efforts to brand him as an inveterate tax hiker. But it carries a high price tag: about $1.4 trillion over the next decade according to the Joint Committee on Taxation.

What’s more, the nation’s fiscal outlook has deteriorated dramatically since the campaign. Massive public spending to avert a financial and economic collapse last year could push this year’s deficit to a record $1.7 trillion. The national debt now stands at about $13 trillion, and is on course to reach 90 percent of GDP by 2020 – not far from Greek-style proportions.

America really can’t afford any of the Bush tax cuts right now. Letting them expire would give the fiscal commission more room to devise a balanced package of spending and tax reforms aimed at whittling down our debts.

But with unemployment stuck in the stratosphere, and with Democrats apparently facing sizable losses in the midterm election, it’s hard to ask them to expose middle-class families to higher taxes – especially when Republicans can be counted on to indulge in monolithic, over-the-top demagoguery.

GOP Senate Minority Leader Mitch McConnell wasted no time in unloading on Hoyer yesterday. “It’s now official. Top Democrats on Capitol Hill are starting to signal their intention to raise taxes on the middle class,” he declared on the Senate floor.

To limit the long-term fiscal impact, centrist Democrats like Hoyer are considering a temporary extension of the middle-class tax cuts. Many liberals, however, are more concerned about the supposed dangers of “austerity” than the nation’s colossal debt burden. In fact, they want to make the cuts permanent now, while Democrats still enjoy big majorities in both Houses.

So chances are Congress will extend the middle-class tax cuts this fall, setting a less-than-inspiring example of restraint for the fiscal commission.

Nonetheless, Hoyer said House Democrats are pushing a budget resolution that would limit discretionary spending; cut deeper than the president’s budget; reinforce PAYGO rules; and commit to a vote on the fiscal commission’s recommendations. It’s a modest down payment on fiscal reform that’s unlikely to suppress demand and throw the economy into a tailspin.

In any case, the contrast between Hoyer’s fiscal realism and the GOP’s denial couldn’t be sharper. Let’s hope Democrats follow their leader.

Photo credit: Center for American Progress Action Fund

Divorce Washington at Your Peril, Silicon Valley

Posted on by The Progressive Policy Institute

Silicon ValleyWashington, D.C. and Silicon Valley are separated by 3,000 miles and vastly different cultures. But if the Valley itself and, more broadly, the U.S. economy are to thrive, then Washington and Silicon Valley need to appreciate each other more than they currently do. From my perch inside the Beltway, I’d like to offer some words of advice for the Valley.

First, I salute your entrepreneurial and organic spirit. It has helped transform the world and create jobs and wealth. But while Washington doesn’t always understand what Silicon Valley does or needs, you need to abandon the myth that Washington had nothing to do with your creation.

Remember: the Internet emerged from the Defense Department’s Advanced Research Projects Agency (ARPA). Oracle got started doing work for the Central Intelligence Agency and Intel sold much of its early output to the Pentagon. Sergey Brin was working on bibliographic research with an National Science Foundation (NSF) grant when he conceived Google. The founders of Genentech and other Bay Area biotech firms relied in part on federal research money to universities. Granted, these and many other companies became forces in the market independent of government, but does anyone really think that the federal dollars that flowed into Stanford, U.C. Berkeley and the Lawrence Livermore Lab had nothing to do with the Silicon Valley of today?

Second, whatever tangential role the feds played years ago, many in Silicon Valley agree with Michael Arrington, editor of the widely read blog Tech Crunch, that it was time for Washington to “just leave Silicon Valley alone.” Oh really? No need for a more generous research and development tax credit? What about intellectual-property infringement? Are the busy people creating and running the companies in the Valley going to lead the charge for cracking down on IP theft in countries like China? What about federal funding for research? I don’t need to tell you that a lot of the best minds and ideas that end up in your companies were trained and/or nurtured at these prestigious California institutions, where federal money flows in from NSF, the Department of Energy, the National Institutes of Health and others. Imagine where the Valley will be in the future without the public private/partnerships and government research dollars. The countries with the fastest broadband are the ones in which government invested in the networks.

Third, don’t kid yourselves — while success in the IT industry in the past might have depended on private companies simply commercializing and marketing their good innovations, success going forward depends on robust public-private partnerships. Intelligent transportation systems, the smart electric grid, mobile payments, digital signatures, health IT and, of course, broadband all represent transformative changes in how we live and work. The commercial opportunities for private companies will be huge, but can companies alone lead the way? Probably not. As we have shown in a report, other nations are ahead of us in all these areas and it is because of smart public private IT partnerships. Only when government commits to the historic redesigns of how we travel, communicate, share data, conduct commerce and use energy will the vast commercial opportunities become accessible for Silicon Valley companies.

Fourth, don’t assume that if government simply loosens up H-1B visa restrictions and lowers taxes, everything else will take of itself. Yes, we need to be able to attract and retain the best minds in the world so we are not starved for talent in the U.S. And yes, we should lower corporate taxes to compete for mobile, high-value-added jobs with countries that have lower effective corporate tax rates. We need to make our R&D credit more generous (we now rank 18th among OECD countries) and should explore tax incentives tied to investment and workforce training workers. But it’s important to note that these countries are matching tax cuts with proactive government efforts to marshal resources to establish leadership in IT and other key economic sectors. Silicon Valley is hanging its fate on a very narrow reed by focusing on worker visas and taxes, and giving short shrift to the many other ways where government plays an integral role in its future.

That leads to the fifth and final piece of advice: Play a more active role in shaping policy in Washington that is good for the country and good for Silicon Valley. Rather than wishing the government would simply cut taxes and leave, get behind government efforts to make innovation a more central part of economic policy. Support more robust investments in national laboratories and university research. Stand up for government efforts to kick start the development of “platform technologies” like the smart grid and intelligent transportation systems. Lead the charge for a better trade policy that defends U.S. innovators against foreign technology mercantilism. Silicon Valley has been the chief beneficiary of Washington’s research and vision, and stands to gain the most from these policies going forward.

Photo credit: caccamo

The Other NPT

Posted on by The Progressive Policy Institute

Nuclear Controlled AreaThis month 189 countries are gathered at the United Nations in New York for a review of the Treaty on the Non-Proliferation of Nuclear Weapons. This review, which has occurred every five years since the treaty was indefinitely extended in 1995, is designed to give the member states the opportunity to discuss how the goals of the treaty are being met — or not. In broad terms, the treaty obliges those members with nuclear weapons to get rid of them and those members without nuclear weapons to never seek them, while promoting peaceful use of the atom by all.

The NPT, as the treaty is informally known, has been highly successful to date: a slow but steady global spread of nuclear power has occurred, while at the same time, many countries have elected to halt nuclear weapons programs and join the treaty regime; three countries — Israel, India and Pakistan — have never ratified the treaty and are either known or believed to have nuclear weapons; only one country — North Korea — has abandoned the regime and developed weapons; and only one country — Iran — is currently believed to be developing a nuclear weapons program while still notionally adhering to the treaty. One of the reasons the NPT has been so successful in promoting nuclear power while damping the spread of nuclear weapons are the guidelines created by the Nuclear Suppliers Group, NSG, a consortium of the countries that build and supply the vast majority of the materials required to build and maintain a nuclear power or nuclear medicine program. These guidelines exist “to ensure that nuclear trade for peaceful purposes does not contribute to the proliferation of nuclear weapons or other nuclear explosive devices which would not hinder international trade and cooperation in the nuclear field.”

It is time, however, to consider a different NPT, namely, a Non-Proliferation Tax. This NPT is the indirect price everyone pays for keeping dangerous nuclear materials and nuclear technologies out of the hands of those who might use it for nefarious purposes. But don’t worry — this isn’t a new tax up for debate.  Rather, it’s part of the current taxes individuals and businesses already pay.

Some of what we get out of this tax is obvious: funding U.S. diplomats and technical experts to work on these issues at the United Nations and other international bodies such as the International Atomic Energy Agency, and to coordinate U.S. work with the NSG. Other efforts are well known, such as those led by the U.S. Departments of State and Energy collectively known as the Cooperative Threat Reduction Program — or Nunn-Lugar Program, for the Senators most responsible for writing the 1992 legislation that created the program. These programs have helped to secure Russian nuclear weapons and fissile materials and to provide Russian and other former Soviet weapons scientists with the training to find work in non-weapons fields; they are being expanded to cover other topics, such as the life sciences, and other parts of the world, such as South and Southeast Asia.

Other efforts that are funded by this non-proliferation tax include the Proliferation Security Initiative, PSI, and the Second Line of Defense, SLD, program. The PSI is a program, started under the G.W. Bush administration and is a collaboration among some 95 countries to intercept illicit shipments of nuclear equipment and materials. The SLD program, also started under the G.W. Bush administration, is installing radiation portal monitors at border crossings and major seaports all over the world in an effort to detect smuggled fissile materials and improvised and stolen nuclear weapons.

Some of these programs are expensive — the SLD program will cost billions of dollars, and the U.S. has spent many more billions over the past 15 years — but the importance of the programs is also irrefutable. Some have calculated that this cost is $50 per month for every household in the U.S.

The problem, though, is that the cost of nuclear proliferation isn’t always obvious to the people, companies, and industries that directly benefit from the nuclear power sources that this money safeguards.  After all, the programs are run by the U.S. government and funded by U.S. taxpayers, not by ratepayers or by the nuclear industry. The goal, then, should be to ensure that nuclear power spreads in a way that doesn’t require a significant growth in the non-proliferation tax. This requires careful examination of new enrichment and reprocessing technologies, to make sure that development and commercialization of these new technologies will not make it harder to safeguard the facilities that use them or to detect covert programs. It also requires the broad industry-wide information sharing program suggested in my last column.

This is not an insurmountable problem, but requires that a holistic view of the costs of the proliferation of nuclear technologies be taken as we see an expansion of nuclear power.

We Can’t Keep Borrowing to Cut Taxes

Posted on by The Progressive Policy Institute

I am going to ever so slightly step out of my comfort zone to relay what I think is a brilliant policy frame for progressives in 2010 and beyond.

Fiscal hawks, like your hosts here at the PPI, have been clear about the stark choices future generations of Americans face. It’s simply not possible to have one of the lowest marginal tax rates in the world along with massive government spending on entitlements programs and defense. If the country is to emerge from the current economic crisis with its financial house in order, something has to give.

Will Marshall took a scalpel to the problem in a post a few weeks ago:

Here’s the blunt truth: the federal government faces a huge revenue hole – too big to be closed by spending cuts alone. Spending last year reached an astonishing 26 percent of national output, while revenues fell to 15 percent. Full economic recovery is expected to cut that yawning tax gap of 11 percent roughly in half.

Getting federal deficits down to a sustainable level – say three percent a year – will require both spending cuts and tax hikes. The president’s deficit-reduction commission will have to look hard at entitlement spending, but we will also need a sweeping overhaul of our tax system to solve our fiscal crisis.

Extending all the Bush tax cuts, of course, will only dig us in deeper. The Congressional Budget Office estimates that extending them through 2017 would cost $1.9 trillion. That doesn’t include the costs of servicing a bigger national debt, or the cost of adjusting the alternative minimum tax so it doesn’t offset the cuts.

So where does the national security guy get off talking about fiscal responsibility? Allow me to explain. There I was last Saturday night, sitting in a bar in Stockholm talking to two Swedes. One was my long-time buddy Eric Sundstrom, political junkie, ex-PPI fellow and current editor of the Social Democrats’ party newspaper. The other was Eric’s pal Torbjorn, who serves as a policy adviser to the Social Dems’ financial team and whose last name was erased from my memory by the time Scotch #3 rolled around.

I was complaining about America’s fiscal imbalance and national allergy to taxes, when Eric piped up and said, “It’s not just an American problem. Torbjorn concocted a brilliant message on it for Sweden, too.”

Smiling, Torbjorn looked up an uttered what could be the defining policy frame on taxes and spending for progressives this year — or any year:

“We can’t keep borrowing money to cut taxes.”

In that form, it’s brilliant in the American context. It puts Tea Partiers on notice that their tunnel vision for lower taxes is costing America dearly. But I’d make one modification to show exactly what’s at stake and where the money comes from:

“We can’t keep borrowing from China to cut taxes.”

Bill Clinton would probably agree. At the Peterson Institute last week, the former president said, “I think this is a national sovereignty issue,” noting that foreign creditors hold 48 percent of America’s debt. China alone holds more than $877 billion of U.S. debt.

So there you go, progressives — a talking point straight from Stockholm on why the right-wing obsession with cutting taxes is so irresponsible.

Cheat Sheet for Climate Policy: Part II – What’s Important for a Good Climate Bill

Posted on by The Progressive Policy Institute

How to tell a good climate bill from a bad one? This series will guide you through the main issues that are likely to arise in the coming weeks as the Senate takes on climate change. In this post we highlight issues that are very important — but not quite essential — in climate policy. These ideas will likely play a key role in the eventual passage of legislation from the Senate. (To read the other posts in the series, click here.)

In our last post we identified the two absolutely critical issues for any climate policy: putting a price on carbon and targeting meaningful emissions reductions. Pricing carbon imposes costs on emitters, thereby changing behavior and encouraging innovation, but it will also generate revenues. Once they are generated, who receives them and how they are spent are important elements of climate policy.

Category II Issues: Key Elements of Climate Policy

#1: Public revenue or private giveaways?

If carbon is priced with a tax, it will generate new government revenues. If, as seems likely, carbon is priced with some form of cap-and-trade, things get a little more complicated. For cap-and-trade to work, emissions allowances must be allocated in some way. The two simplest ways to allocate allowances are to give them away for free, or to auction them to the highest bidder. Only the latter would generate any new public revenues. Allowances are assets with real value, so giving them away is no different from a government subsidy to the recipient.

Auctioning allowances is generally more efficient than giving them away — society as a whole is better off the more allowances are auctioned. Nevertheless, many groups of emitters or industries have made arguments (and will continue to do so) that they should be given free allowances. They argue the impact of climate policy on their industries will be too onerous or that they represent the interests of their consumers. Generally speaking, these claims are old-fashioned Washington handout-seeking behavior.

Fights over allowance allocation were predictably rampant when the House considered its bill, Waxman-Markey, last year. Comparatively few allowances would be auctioned under Waxman-Markey, especially before 2020, and substantial allowance handouts (35 percent of allowances) would be given to local gas and electricity distribution companies, ostensibly to protect consumers from increases in electricity prices. It is very likely that allocation will again be a central (possibly the central) political issue in the Senate debate.

A carbon price won’t affect every person, firm, or industry equally. In particular, low-income households will feel the effects of a carbon price far more than wealthy households, and an equitable climate policy should compensate the losers to offset that disparity. The best way to do so would be to compensate them with cash (through direct rebates or tax cuts) raised from auctions – yet another factor in their favor. Under a giveaway scenario, the government could hand out free allowances to utilities, hoping that they pass along savings in the form of lower energy prices. That may help consumers, but they would still be better off if they receive the savings directly out of auction or tax revenues and can make their own choices about how to spend that compensation—more on how these revenues could be spent in the next section. Besides, lower consumer energy prices can blunt the price signal a cap sends, leading to increased energy usage.

However attractive auctioning all allowances is, it’s probably not politically realistic. Handouts will probably have to be made to some industries to get votes for the bill (though there’s still hope, on both the right and left, that the general welfare can prevail over handouts to special interests ) In any case, auctions are the most desirable distribution mechanism, and should be a major component of any climate legislation.

#2: What do we do with the money?

Assuming you’ve auctioned at least some allowances (or have revenues from a carbon tax), what should the government do with the money? There is no easy answer here, but in general we have three options:

a) Reduce existing taxes

If the government receives revenues from a carbon price, one response is to cut the taxes already on the books. Reducing other taxes shifts the U.S. tax burden from those who currently bear it (primarily income earners) to carbon emitters and, indirectly, to consumers of carbon-intensive goods and services. In general, this is a good thing, for the simple reason that you are lowering taxes on something you generally want people to do (work) and raising them on something you don’t want them to do (emit carbon). In economic terms, you move from taxing something we generally think has positive externalities to something we know has negative externalities. And politically, who doesn’t like lower taxes? One drawback is on that you may end up reducing progressive income taxes in favor of carbon pricing, whose costs might be harder to bear for those who can least afford it.

b) Dividends to consumers

If you’re troubled by the possibly regressive character of tax cuts, but think returning carbon price revenues to the people ultimately affected by increased prices is a good idea, then a good alternative is direct payments to consumers. This is the “cap-and-dividend” approach taken by the Cantwell-Collins bill in the Senate that Danny wrote about recently. Under cap-and-dividend, revenues generated by an allowance auction (or a carbon tax) are used to make payments directly to consumers. In other words, every household would get a check. Because all households would get equal payments, the plan turns a somewhat regressive carbon price scheme on its head by transferring money from those with a large carbon footprint (often the wealthy) to those with a smaller one (often the poor). Politically, it’s broadly appealing—even conservatives that tend to oppose redistribution of wealth find a lot to like, in large part because dividends “cut government out of the picture.”

Instead of sending everyone the same amount, it’s also possible to try to identify specific losers from climate policy and compensate them directly. One example of such relative losers might be trade-exposed industries, who would stand to lose competitive ground against foreign firms not subject to a carbon price (more on this issue later in the series). Making payments to industries instead of households isn’t usually characterized as cap-and-dividend, but the difference is only distributional—who gets the money. One disadvantage is that direct dividends pose a bureaucratic challenge — there is no clear mechanism for distributing them.

c) Public goods

Alternatively, the government could spend the revenues from an auction. In some cases, the government can create greater benefits by spending revenues than by giving them back. Restricting ourselves to climate-related spending, good examples might be energy R&D, investments in adaptation to climate change, or efforts to reduce emissions internationally or verify international emissions offsets. Indeed, the federal government will need to spend money in some of these areas regardless because the private sector may underinvest in energy R&D, and will almost certainly underinvest in climate change adaptation and international mitigation efforts. The Waxman-Markey bill devotes auction revenues to many of these areas, and a Senate bill probably will (and, in large part, should) do the same.

Of course, carbon price revenues could also be used for any other government expenditure, from education to infrastructure or defense. Revenues could also be used to pay down the debt. Any of these might be worthwhile expenditures, but it’s important to remember that any revenues that are not returned through dividends or lowering other taxes represent a tax increase on anyone who uses carbon—that is, everyone. Opponents of action on climate often characterize it as a major tax increase. To the extent that revenues from a carbon price are dedicated to unrelated government expenditures, this criticism isn’t dirty politics, it’s a fact. Taxing and spending on a given project may or may not be a good idea, but bringing carbon into the picture doesn’t change the fact that it’s taxing and spending.

#3: Market design: banking and borrowing

A major policy and political priority for climate legislation is to reduce emissions as effectively and cheaply as possible. Whether this goal proves to be attainable or not depends greatly on how cap-and-trade markets are designed. While these issues tend to fly under the radar of the political debate — partially because they are complex and partially because they are not very sexy — they have major implications not only for how firms will behave under a cap-and-trade system, but the timing of actual emissions reductions.

There are multiple options for controlling the costs of climate legislation compliance (most of which will covered in our next post), but the key aspects are the closely related concepts of banking and borrowing of allowances. The general concept of banking isn’t terribly complicated: firms ‘bank’ allowances by overcomplying with the cap (they reduce their emissions more than is required) throughout the program, thus building a surplus of allowances that they can use at a future date. Similarly, firms may choose to ‘borrow’ allowances, by using an allowance from a future year, then repaying that allowance with future reductions (possibly with interest).

Polluting firms have two reasons why they want to be able to bank and borrow. First, the path of the lowering cap (established by legislation) will likely not be set in a way that is optimal for regulated parties. Banking and borrowing credits gives them the flexibility to take an emissions-reduction path that is most cost effective, either by filling their bank with credits through overcompliance in the early years of the market or by borrowing in later years if they expect some kind of efficiency increase to come through at a certain future time. Second, banking and borrowing can protect firms against unforeseen shocks to their compliance paths. For instance, a company may have unanticipated problems that force it to use a more carbon-intensive energy source, increasing its emissions above the number of allowances it possesses. Borrowing allows the firm to get more allowances now in exchange for stronger future reductions.

While some may claim that banking and borrowing look like a way to game the system, they are simply mechanisms to help firms control costs and reduce their emissions as efficiently as possible. A strict cap-and-trade system where firms can only trade amongst each other would be more expensive. Banking and borrowing helps reduce costs while still achieving the cumulative emissions reductions desired. A study by Resources for the Future scholars Harrison Fell and Dick Morgenstern contends that borrowing generates significant cost savings, especially when the cap is being lowered at some rate (which is the case in all serious climate proposals). If borrowing is restricted, costs go up.

Allowance banking and borrowing are key issues for climate policy because they will not only play a major role in the behavior of firms in the cap-and-trade market, but they will also have a strong influence on the actual path of emissions reduction. This gets back to the point we made in the last post, where we said that specific reduction targets don’t matter as much cumulative emissions reductions. The ability to bank means that carbon polluters may strongly overcomply, meaning that they will reduce far beyond the 17-20 percent reduction goals in 2020. Analyses from the EPA and the EIA back this up. The flipside, however, is reductions in later years may be less than the cap as companies start to cash in their banked allowances. As long as the cumulative emissions over the life of the regulation come in under the cap, it’s fine for the year-to-year levels to be ruled by how regulated parties bank and borrow.

The Bottom Line

In the last post, we presented three issues that we deemed essential to any climate bill. Here we discuss the merely important:

  1. How are emissions allowances allocated—are they auctioned, or given away?
  2. How are the public revenues from climate policy spent?
  3. Is the allowance market designed for economic efficiency—does it allow banking and borrowing?

In our next post, we will travel further down the rabbit hole and address some further issues climate policy that are still relevant and meaningful, but less important than what we’ve talked about so far.

Photo credit: https://www.flickr.com/photos/uwehermann/ / CC BY-SA 2.0

Reality Check on Taxes

Posted on by The Progressive Policy Institute

Americans are increasingly alarmed by the nation’s massive deficits. Yet according to a new CNN poll, 60 percent favor making the Bush tax cuts permanent, instead of letting them expire this year. This doesn’t compute. If President Obama is to make any headway in restoring fiscal discipline in Washington, he will have to inject a note of realism into the debate over taxes and spending.

Here’s the blunt truth: the federal government faces a huge revenue hole – too big to be closed by spending cuts alone. Spending last year reached an astonishing 26 percent of national output, while revenues fell to 15 percent. Full economic recovery is expected to cut that yawning tax gap of 11 percent roughly in half.

Getting federal deficits down to a sustainable level – say 3 percent a year – will require both spending cuts and tax hikes. The president’s deficit-reduction commission will have to look hard at entitlement spending, but we will also need a sweeping overhaul of our tax system to solve our fiscal crisis.

Extending all the Bush tax cuts, of course, will only dig us in deeper. The Congressional Budget Office estimates that extending them through 2017 would cost $1.9 trillion. That doesn’t include the costs of servicing a bigger national debt, or the cost of adjusting the alternative minimum tax so it doesn’t offset the cuts.

Obama pledged during the campaign to keep the Bush cuts for households making under $200,000 a year. He will either have to break that very expensive promise, or turn to other possible revenue sources. What are the options?

The first, and most attractive, is to go after the hundreds of billions of tax subsidies that range from specific industry tax breaks to broader provisions – like the health care exclusion and mortgage interest deduction – that benefit all taxpayers. This is the essence of an intriguing bill crafted by Sens. Ron Wyden (D-OR) and Judd Gregg (R-N.H.), which would broaden the tax base by eliminating all itemized deductions except for mortgage interest and charitable deductions.

Another option is to look for new revenue sources. The best would be a charge on carbon, which would raise revenue, boost clean energy investment and protect the earth’s climate all in one fell swoop. The emerging Senate climate and energy compromise, engineered by Sens. Kerry (D-MA), Graham (R-S.C.) and Lieberman (I-CT), would cap carbon emissions, but it appears that the revenues would be rebated to the public. This approach would blunt Republican charges that putting a price on carbon is tantamount to raising taxes in a weak economy, but it wouldn’t close our revenue gap.

That’s why there’s rising interest in a value-added tax (VAT). Paul Volcker, the éminence grise of high finance, floated the idea recently. It’s also been endorsed by leading progressive thinkers like Isabel Sawhill and Henry Aaron of the Brookings Institution. A VAT has traditionally been seen as a harbinger of European-level taxes, but Sawhill believes it may be the only way to finance health care. She adds:

In the end, any tax increase will be a heavy lift in a country that seems allergic to paying its bills. But it will have to happen sooner or later and sooner would be much better. As Larry Summers once noted, Republicans don’t like value-added taxes because they are a revenue machine and Democrats don’t like them because they are regressive. We will get a VAT when Democrats realize they are a revenue machine and Republicans realize that they are regressive.

Photo credit: https://www.flickr.com/photos/rhruzek/ / CC BY-NC-ND 2.0

Democracy as a Free Lunch for Islamofascists

Posted on by The Progressive Policy Institute

As I am sure you have noticed, one of the big conservative talking points in recent months has been that the Obama administration and congressional Democrats despise democracy because they have (sic!) used “revolutionary methods” to (sic!) “cram down” health reform against the manifest wishes of the American people, who wisely oppose socialism. Fortunately, Republicans are determined to help Americans “take back their country” in November.

But at the very same time, bless them, conservatives can’t help but express some long-held negative feelings about this small-d-democratic claptrap. One sign is their great hostility to any efforts to encourage higher levels of voting (though this is typically framed as opposition to “voter fraud,” evidence for which is completely lacking). Another is the Tea Party theory that there are absolute limits on the size and cost of government that either are or should be enshrined in the Constitution or enforced by the states, regardless of the results of national elections. And still another involves periodic bursts of outrage over people who don’t pay income taxes being allowed to vote.

This last meme got a boost very recently when estimates emerged that 47 percent of U.S. households won’t have any 2009 federal income tax liability.

“We have 50 percent of people who are getting something for nothing,” sneered Curtis Dubay, senior tax policy analyst at the Heritage Foundation.

Sean Hannity chipped in with alarums about the implications of “half of Americans not paying taxes.”

One conservative site took the AP story on this data and added this helpful subtitle: “Tax Day Is Just Christmas For Many.”

Another had an even more suggestive title: “Let’s Make You Spend More on Me,” along with a chart showing upward federal spending trends. This interpretation is clearly just a hop, skip and jump from the “culture of dependency” rhetoric most famously expressed by South Carolina Lt. Gov. Andre Bauer in his speech comparing subsidized school lunch beneficiaries with stray animals who shouldn’t be encouraged with free food. And in retrospect, Bauer showed some unorthodox brilliance in galvanizing conservative anger about socialist “free lunch” redistribution toward kids who are literally receiving free lunches.

Now the various conservative “analysts” of the free-lunch, free-rider phenomenon rarely go to the trouble of acknowledging that most of that lucky 47 percent not owing federal income taxes (which represent less than half of federal revenues) pay high and very regressive federal payroll taxes, not to mention even more regressive state and local sales and property taxes. Nor do they note that most non-federal-income-tax-paying households are either retirees living on savings and retirement benefits or working poor families with kids (the beneficiaries of those child tax credits that conservatives are always promoting as “pro-family” policies). And I’ve yet to see even one concede that the 47 percent figure is a temporary spike attributable to the recession and to short-term tax credits that will expire with the economic stimulus program.

While the reverse-class-warfare subtext of some of the conservative angst about alleged tax-and-benefit freeloaders is pretty clear, there are those who would link it to an even more lurid, culture-war theme. Check out this remarkable weekend post from National Review’s Mark Steyn, who compared our system of “representation without taxation to” — no, I’m not making this up! — Muslim oppression of non-Muslims. Gaze in awe:

United States income tax is becoming the 21st-century equivalent of the “jizya” — the punitive tax levied by Muslim states on their non-Muslim citizens: In return for funding the Islamic imperium, the infidels were permitted to carry on practicing their faith. Likewise, under the American jizya, in return for funding Big Government, the non-believers are permitted to carry on practicing their faith in capitalism, small business, economic activity, and the other primitive belief systems to which they cling so touchingly.

So there you have it: socialism and Islamofascism nicely bound up in the policies of that madrassa-attending elitist, Barack Obama.

However you slice it, the conservative commitment to democracy sometimes seems limited to those “real Americans” who think right and vote right. At a minimum, progressives should not let them combine such attitudes with pious invocations of the Popular Will.

This item is cross-posted at The Democratic Strategist.

Photo credit: https://www.flickr.com/photos/katerkate/

Knowing What You Paid For

Posted on by The Progressive Policy Institute

‘Tis the season to fill out your tax forms — and, for many Americans, to complain about all the tax dollars that disappear into the maw of what they see as an indifferent government. But it doesn’t have to be this way. Democracy‘s Ethan Porter has a great idea to increase Americans’ sense of investment in their government:

[L]et’s offer individual taxpayers a clear breakdown of what they’re getting in return for their taxes. The IRS should provide individual taxpayers with a receipt. To be as accurate a reflection of spending as possible, such a receipt would be mailed at the beginning of the year following the April 15 deadline. So, for example, I would receive a receipt for my 2009 tax return, filed in 2010, in the beginning of 2011 estimating where my money has gone thus far, and will go until I file my next return. Soon after, the president would unveil a new budget resolution, and, as April loomed, the process would begin again.

By necessity, such a receipt would be an estimate, broken down according to what each taxpayer had paid the previous April. (Only the portion of the budget consisting of money generated by individual taxpayers would be deconstructed for each person.) The receipt would necessarily represent a bit of an oversimplification–the federal budget is a monstrously complicated thing. For our purposes, comprehensibility, as opposed to comprehensiveness, should be prized. The text should be simple, and the accompanying graph should be clear. We have the capacity to do this already: Today, numerous outside groups, the Center on Budget and Policy Priorities probably the best among them, produce material along these lines. But they don’t do so in accordance with the federal government, and their work isn’t distributed to every taxpayer.

If done right, a receipt could have powerful and lasting consequences. It would make clear the enormous amount of goods and services provided by the government.

Even as conservatives have launched a largely successful crusade against taxes over the last couple of decades, public demand for services that the government provides hasn’t waned. The result is a disconnect: anger at the level of taxation — which has already been generally decreasing since the 1970s — and yet a steady expectation of goods and services from a government that relies on taxpayer money to sustain itself.

Considering the misconceptions the public has about where their taxpayer money goes, Porter’s idea could be a great corrective to the conservative narrative of a government squandering its tax dollars or prioritizing areas of less importance to them. As Porter points out, Americans tend to overestimate how much of the money goes toward things like welfare and foreign aid. When confronted with the fact that those numbers are actually small compared to other expenses like national defense and Social Security, taxpayers may see the check that they’re dropping in the mailbox every spring in a whole new light.

It’s no secret that the U.S. is going to have to find new ways to cut spending or raise revenues to steer us off our current path of fiscal disaster. An informed taxpayer might be more realistic about the hard choices necessary on both sides of the budgetary ledger. A receipt for our tax dollars will make for a less inflamed electorate — and, by extension, plant the seeds for a more reasonable fiscal politics.

The Tea Party’s Retreaded Ideas

Posted on by The Progressive Policy Institute

For all the talk about the Tea Party Movement and its demands that America’s political system be turned upside down, it’s always been a bit hard to get a fix on what, exactly, these conservative activists want Washington to do.

To solve this puzzle, it’s worth taking a look at the Contract From America process — a project of the Tea Party Patriot organization, designed to create a bottoms-up, open-source agenda that activists can embrace when they gather for their next big moment in the national media sun on April 15. The 21-point agenda laid out for Tea Partiers to refine into a 10-point “Contract” is, to put it mildly, a major Blast from the Past, featuring conservative Republican chestnuts dating back decades.

There’s term limits, naturally. There are a couple of “transparency” proposals, such as publication of bill texts well before votes. But more prominent are fiscal “ideas” very long in the tooth. You got a balanced budget constitutional amendment, which ain’t happening and won’t work. You got fair tax/flat tax, the highly regressive concept flogged for many years by a few talk radio wonks, that has never been taken seriously even among congressional Republicans. You’ve got Social Security and Medicare privatization (last tried by George W. Bush in 2005) and education vouchers. You’ve got scrapping all federal regulations, preempting state and local regulations, and maybe abolishing some federal departments (an idea last promoted by congressional Republicans in 1995). You’ve got abolition of the “death tax” (i.e., the tax on very large inheritances). And you’ve got federal spending caps, which won’t actually roll back federal spending because they can’t be applied to entitlements.

My favorite on the list is a proposal that in Congress “each bill…identify the specific provision of the Constitution that gives Congress the power to do what the bill does.” This illustrates the obliviousness or hostility of Tea Partiers to the long string of Supreme Court decisions, dating back to the 1930s, that give Congress broad policymaking powers under the 14th Amendment and the Spending and Commerce Clauses. This illustrates the literalism of Tea Party “original intent” views of the Constitution; if wasn’t spelled out explicitly by the Founders it’s unconstitutional.

We are often told that the Tea Party Movement represents some sort of disenfranchised “radical middle” in America that rejects both major parties’ inability to get together and solve problems. As the “Contract From America” shows, that’s totally wrong. At least when it comes to policy proposals, these folks are the hard-right wing of the Republican Party, upset that Barry Goldwater’s agenda from 1964 has never been implemented.

Photo credit: https://www.flickr.com/photos/bisongirl/ / CC BY 2.0

Taking It to the Banks

Posted on by The Progressive Policy Institute

Following a week of trial balloons about a tax on banks and bankers, President Obama today unveiled a “financial crisis responsibility fee,” to be levied against 50 of our nation’s largest banks. While the tax will not be able to seriously address the deficits that the government faces – it’s expected to raise only $90 billion over 10 years – any tax on the financial system can affect the course of our economy. The details of the proposed tax have yet to be outlined. Compared to the alternatives, this tax is a good start – but it doesn’t go far enough.

In the discussion of taxing banks and bankers, a couple of possibilities have been floated, some of which can reap short-term political points, others of which have the potential to promote progressive policies:

Bonus tax – One of the easiest – and politically most satisfying – would be a tax on excess bonuses. The British exercised this option on London bankers this past year. Bonuses in the City above a certain amount were taxed at a 50 percent rate. Banks responded by threatening to move offshore and – when that threat rang hollow – doubled the bonus pool they paid out to bankers. The end result was that the bankers whose decisions led in part to the crisis were financially unharmed, the British government raised a relative pittance in taxes, shareholders in City banks took a hit (as the bonus pools were increased at their expense), and the underlying fault lines in the British banking system remain unaddressed.

Transaction tax – The worst of the options would be a tax on transactions. As discussed before, this would merely pour sand in our financial system, breaking it and slowing economic recovery.

Excess profits tax – A more appealing option would be a tax on excess profits. A defining aspect of the financial bubble of the last decade was the fact that financial profits were 40 percent of overall corporate profits – more than double the slice financials made up of profits in the 1980s. A tax on these excess profits would rein that in. But while this could be useful, as Simon Johnson points out, it would be fairly easy to game, and end up being ineffective.

Tax on assets – A tax on bank assets above a certain amount addresses not just political sentiment that banks have made it through the crisis unscathed, but also the fact that banks are too big to fail. Encouraging banks to “right-size” themselves would make our economy safer from the systemic risk imposed by banks like Citigroup or Bank of America – which are debilitated but whose failure would be economically catastrophic.

Excess leverage tax – Taxing the leverage that financial institutions use to increase returns would allow us to avoid situations like that faced a year and a half ago when Lehman Brothers – leveraged over 30:1 – collapsed over the course of a weekend. It would make banks “safer” but would leave them still too big. In the event a bank were to fail, it would still be a systemic threat to our economy. This would be a more targeted version than an assets tax, but it would be harder to implement — definitions of leverage differ – and if not properly defined would leave hedge funds, insurance companies and other “non-bank financial institutions” untouched, leading to a crisis like that perpetuated by Long-Term Capital Management in 1998 or AIG last fall.

The taxes unveiled today are a very tentative step down the path towards an effective tax on assets. But the administration’s proposal is too broad – affected institutions could be as small as $50 billion — and too light to be effective.

If the Obama administration were strictly looking to tax the problem of an outsized and dangerous financial industry out of existence, a combination of the last two taxes — properly implemented to cover the whole financial sector when looking at leverage and focused on banks that are bigger than, say, $300 billion when looking at assets — would be the most effective. But hastily implemented, they could have unintended consequences, crippling our economy while merely pushing the problem offshore. Coordination with the EU and other G-20 countries will be vital to help with the de-leveraging of our economy.

States Undermining Stimulus

Posted on by The Progressive Policy Institute

It’s reasonably well understood that this year’s federal economic stimulus legislation helped (though not as much as it might have) cushion state and local governments from a fiscal disaster attributable to falling revenues, automatically increasing entitlement expenditures, and balanced budget requirements. The rationale for this federal aid — to keep states and localities from counteracting the stimulative effect of federal spending via tax increases and spending cuts — is less well understood. So, too, is the fact that the continuing fiscal crisis around the country continues to undermine the impact of federal stimulus.

That’s the departure point for an important new article by Harold Meyerson in The American Prospect. Aggregating the numbers, Meyerson reaches a startling but entirely justified conclusion:

[H]ow much does the government’s stimulus come to when we subtract the amount the states and localities are taking out of the economy from the amount the feds are putting in? The two-year Obama stimulus amounted to $787 billion, of which $70 billion was really just the usual taxpayers’ annual exemption from the alternative minimum tax, and $146 billion was actually appropriated for the years 2011 to 2019. That leaves $571 billion that the federal government is pumping into the economy during 2009 and 2010. Subtract the amount that state and local governments are withdrawing from the economy (they have a combined shortfall of around $365 billion, but let’s say they do enough fiscal finagling so that the total of their cutbacks and tax hikes is just $325 billion), and we’re left with $246 billion.

At $787 billion, the stimulus came to 2.6 percent of the nation’s gross domestic product for 2009 and 2010 — not big enough, but a respectable figure. At $246 billion — the net of the federal stimulus minus the state and local anti-stimulus — it comes to just 0.8 percent of GDP, a level lower than those of many of the nations that the U.S. chastised for failing to stimulate their economies sufficiently.

In other words, most of the debates we’ve heard about the size and impact of the federal stimulus effort have ignored the actual net spending once you aggregate federal, state and local government actions. That’s a pretty big omission, and that’s why the University of Chicago’s Harold Pollack and I argued earlier this year that we need to start thinking comprehensively about intergovernmental coordination:

[F]ederal budget debates should expand to include the national budget, the sum total of spending, taxes and policies that implement and finance national governance. At a minimum, the Office of Management and Budget and the Congressional Budget Office should routinely scrutinize the financial impact of proposed federal policies on every level of government.

Meyerson goes on to examine other damaging aspects of our federal system with respect to economic policy that are well worth reading. But what’s most interesting and alarming about his analysis is that it’s so unusual. Most policy discussions in Washington either ignore state and local governments, treat them as an unimportant sideshow, or assume that the many parts of the intergovernmental system move roughly in coordination, and in the same direction. Now more than ever, it’s time to understand that the left hand of our system may be working at active cross-purposes with the right.

A Different Take on the Financial Transaction Tax

Posted on by The Progressive Policy Institute

Having just joined the Progressive Policy Institute from a stint on Wall Street, I’d like to offer a different perspective on the financial transactions tax (FTT).

Last week, Lee Drutman argued in favor of an FTT, saying that a transaction tax modeled after the one our British friends have would raise much-needed funds. Writing in light of the past year’s economic crisis, Drutman also said that an FTT would “throw a little sand in the gears of the giant financial speculation casino.” While both raising revenue and reining in Wall Street are goals worth pursuing, I would argue that the FTT is a second-best solution.

According to Dean Baker of the Center for Economic and Policy Research, a proponent of the FTT, a Yankee equivalent of John Bull’s 0.25% transaction tax wouldn’t raise $100 billion — it would raise less than a third of that. You need to crank up the tax — to double the proposed amount on stocks and higher on other products — to get close to a hoped-for $100 billion in revenue.

Also, it’s worth pointing out that a transaction tax didn’t spare the British from any of last year’s financial crisis — they had housing crises, government bailouts, and bank nationalizations comparable to what we saw on this side of the Atlantic.

A transaction tax is simply too blunt an instrument. Pouring sand in the gears is not a way to slow a machine down — it’s a way to try to bring the machine to a halt. Trying to second-guess trader activity by taxing stocks and other securities at differing levels to generate sufficient revenue will only drive broker dealers to encourage trading in high-margin products to make up for the dead-weight loss of the tax. This would drive traders away from liquid products to illiquid ones, increasing systemic risk. This increased focus on complex structured products drains liquidity from the system, as we saw last fall.

A better solution is one along the lines in Sen. Chris Dodd’s (D-CT) proposed financial reform bill. In addition to heightened capital and leverage requirements for systemically significant, “too big to fail” banks, higher capital requirements and stricter leverage controls could be imposed on trading in complex financial instruments. This would drive Wall Street firms looking to goose returns through leverage from trading the complex products that contributed to last year’s crisis to more liquid — less systemically threatening — products.

Investors that would want to speculate on complex derivatives could still do so, providing they did it with their own money. And banks that wanted to sell those products could still do so, provided they had adequate capital to backstop those activities. Letting these properly priced incentives work their magic would allow the market to behave in a responsible manner. Revenue could then be generated from that market activity by taxing gains made by speculators at a rate in line with income tax rates.

This would achieve the goals the FTT sets out to do — rein in derivatives risk and raise revenues — in a way that leaves market forces free to be a driver of renewed growth in our economy. But I suspect the supporters of the FTT will want to have their say, and I look forward to hearing it.

The Real Reason to Support a Financial Transaction Tax

Posted on by The Progressive Policy Institute

Thanks to Gordon Brown’s support, the idea of a financial transaction tax has been gaining a bit of attention over the last couple of weeks. The idea is simple: place a small tax (say, 0.25 percent or less) on all financial transactions.

Partially, it’s a way to raise a little revenue from those who can most afford to pay to create an insurance fund against future bailouts, which is how it is being billed. And just yesterday, it was reported that House Democrats have discussed using it to fund a jobs bill. (Dean Baker has estimated that the tax could bring in $100 billion.)

But mostly, it’s a good idea because it throws a little sand in the gears of the giant financial speculation casino.

Wall Street banks make a good deal of money by running very sophisticated computer programs, looking for tiny (and supposedly risk-free) arbitraging opportunities, and then making those opportunities pay off by investing with incredibly high volume. These trades are something like the equivalent of buying a bunch of dollars for 99.75 cents each. It’s a great deal if you can do it en masse, and an even better deal if you can also borrow almost all of the money you are investing.

But if banks had to pay a 0.25 percent tax on every dollar they sold, then it suddenly wouldn’t seem like such a good deal to buy dollars for 99.75 cents each. This is what a transaction tax would do.

This would mean that Wall Street banks would spend less time looking for short-term opportunities to buy dollar bills for 99.75 cents. This a good thing, because it’s hard to see how having some of the smartest people and most sophisticated computer programs dedicated to this kind activity helps the economy. Something is wrong when 40 percent of all U.S. corporate profits are coming from the financial sector, as they were for much of the 2000s.

A transaction tax would mean that banks would instead devote more time to investing their capital in good, long-term investments. This seems to me what a banking sector is supposed to do — allocate capital to the most promising business ventures, which then sometimes actually spur innovation and improve the standard of living for everyone, not just those who happen to be clever enough to take part in the big casino.

Unfortunately, Treasury Secretary Tim Geithner is against such a tax, and his support is pretty important, since any transaction tax would require an international agreement. This is not surprising, since Geithner is and always will be a creature of Wall Street.

Still, it’s hard not to marvel at the latest round of bonuses on Wall Street and wonder how it is that these guys are making $30 billion while the economy continues to stumble. Slowing down the Wall Street speculation machine might help channel some energy elsewhere — maybe into actual productive recovery.

A Chart That Should Keep Progressives Up at Night

Posted on by The Progressive Policy Institute

In my last post, I noted that progressives need to turn their attention toward the medium- and long-term fiscal crisis the country faces. How massive is the challenge we face? The following chart, from Keith Hennessey, an ex-Bush policy advisor, says it all:

taxes-and-spending-long-term-trends 2

Obviously the first thing to jump out is the escalating divergence between federal spending and revenues in the decades ahead. And the spending projection in the chart is from 2007, so it doesn’t include the stimulus or spending on the financial crisis (or the projected cost of health care reform). That’s scary enough. But the scariest part may not be evident at first glance.

The red line shows federal taxes as a percent of GDP going back to 1945 and projected outward to 2080 by Hennessey based on its historic growth. The yellow line shows federal spending as a percent of GDP. The chart makes clear that the level of federal taxation has actually varied little since World War II (which says nothing about how marginal tax rates faced by different groups have changed). You can see the last build-up of deficits that occurred from the 1970s through the mid-1990s. You can also see the build-up of the Bush years.

Historic Shortfalls

The kind of budget shortfalls we are looking at in the future dwarfs anything we’ve ever seen. There are two ways to close the fiscal gap – cut spending or increase revenues. What Hennessey’s chart makes clear is that the level of taxation it would require to meet projected spending needs is far higher than anything the country has ever seen-slash-tolerated. Indeed, even closing half the gap through higher taxes would necessitate historically unprecedented taxation levels.

Progressives, in short, are going to be caught between a rock and a hard place: we will either have to find a way to convince the electorate to go along with massive tax hikes, with all of the electoral risk that entails, or we will have to come up with a plan to make equally massive cuts to entitlements that are likely to also be unpopular and that may do significant harm if not thought through carefully.

It’s true that the right will also be caught in this dilemma, but its situation is not quite as severe for two reasons. First, as the chart implies, their preferred path to fiscal sanity (spending cuts) starts off a much easier sell than tax hikes, given historical patterns. And second, the right has little programmatic interest in permanent spending hikes. The Reagan and Bush years showed that there is a constituency on the right for greater defense spending, but unless we really end up permanently at war with radical Islam, it can be expected that the Pentagon’s budget will rise and fall as global circumstances dictate. Progressive goals, on the other hand, such as greater federal education spending, expansion of child care assistance, more generous safety nets, and broader social insurance constitute costly and (ideally) permanent spending increases that will exacerbate the fiscal gap in the above chart.

The Upshot for Progressives

What does this mean for the progressive agenda? First, it is vital that we prioritize our goals, a process that is going to require us to drop many of them, as difficult as that may be. Second, we need to come to terms with what “higher taxes” is going to mean in practice. U.S. taxation is actually as progressive as in Europe because we have taken so many families off of the income tax rolls. The added boost to raising taxes on “the rich” is much smaller than the revenue that could be raised by broadening the tax base so that we were not so reliant on upper-income families to pay for the benefits of government that everyone enjoys.

Third, we need to look for ways to achieve progressive aims that do not cost the federal government so much. That could include certain types of regulation, but it could also include a shift toward progressive cost-sharing in social insurance programs. Rather than trying to raise taxes to give people the benefits they say they want, we could move toward a paradigm where people gradually incur increasing costs of these benefits privately, forcing them to directly confront the trade-offs and efficiency concerns that social insurance tends to hide. Those with limited incomes could receive federal assistance but would still be incentivized to use benefits efficiently. (I will suggest what such programs might look like in future pieces here.)

Some progressives may object to the idea of progressive cost-sharing because it shifts costs and risk onto individuals. But they are going to incur the costs one way or another, whether through higher taxes or greater out-of-pocket spending. And given the impracticality of paying for future benefits solely out of taxes, risk is also likely to be privatized either way — whether by a thoughtful policy framework or through massive cuts in existing programs.

But let there be no doubt — the long-term prospects for significantly expanded progressive government are dim, and in fact, a retrenchment in coming decades is inevitable. President Clinton was wrong — the Era of Big Government is not over. But it will be soon. As progressives we must lead the process of winding it down in a responsible and fair way.