Tax Policy and the Economy

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 ).

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 ...

Three tax credits benefit households who pay tuition and fees for higher education. The credits have been justified as an investment by generating more educated people and thus more earnings and externalities associated with education. The credits have also been justified purely as tax cuts to benefit the middle class. In 2009, the generosity of and eligibility for the tax credits expanded enormously so that their 2011 cost was $25 billion. Using selected, de-identified data from the population of potential filers, we show how the credits are distributed across households with different incomes. We estimate the causal effects of the federal tax credits using two empirical strategies (regression kink and simulated instruments), which we show to be strong and very credibly valid for this application. The latter strategy exploits the massive expansion of the credits in 2009. We present causal estimates of the credits’ effects on postsecondary attendance, the type of college attended, the resources experienced in college, tuition paid, and financial aid received. We discuss the implications of our findings for society’s return on investment and for the tax credits’ budget neutrality over the long term (whether higher lifetime earnings generate sufficient taxes to recoup the tax expenditures). We assess several explanations as to why the credits appear to have negligible causal effects.

The Affordable Care Act (ACA) introduces or expands taxes on incomes and full-time employment, beginning in 2014. The purpose of this paper is to characterize the new full-time employment taxes from the perspective of a household budget constraint, measure their magnitude, and assess their likely consequences for employee work schedules. When the ACA is fully implemented, full-time employment taxes will be prevalent and often as large as what workers can earn in five hours of work per week, 52 weeks per year. The economic significance of the ACA’s full-time employment taxes varies by demographic group: they are nonmonotonic in age, increasing with family size, and negatively correlated with schooling.

A full-time employment tax is a tax or penalty owed by, or subsidy withheld from, a person as a consequence of his full-time employment status. For the first time in 2014, millions of people face such taxes on their full-time work. More workers will face full-time employment taxes in 2015 when assessable employers owe penalties on the basis of the number of full-time employees on their payroll. Both of these taxes are provisions of the Affordable Care Act of 2010 (hereafter, ACA), on top of the longstanding taxes on incomes and payroll. This paper assesses the magnitude, direction, and economic characteristics of the full-time employment tax wedges created by the ACA.

By definition, part-time employed and nonemployed persons are exempt from a full-time employment tax. I follow the usual steps of public finance analysis and first look at the tax wedge—the gap between supply and demand prices created by a tax or subsidy—before attempting to draw conclusions about the tax’s behavioral effects and ultimate incidence. For simplicity, I assume that employees are legally liable for all marginal taxes and penalties and are legally entitled to all marginal subsidies, even when the actual liability falls on the employer. As long as prices can fully adjust to reflect supply and demand, and ignoring enforcement issues, my legal liability assumption is just a normalization and does not imply that employees ultimately bear the burden of taxes. However, proper tax measurement requires an assessment of the treatment of the ACA’s full-time employment taxes by other parts of the tax system, for example, whether a full-time employment tax is deductible from employer business income taxes. The last step in the analysis is to begin to consider the equilibrium consequences of the new tax wedges.

The prevalence and size of the new full-time employment tax (hereafter, FTET) wedges are economically important. Almost half of the working population is directly affected by at least one of the new FTETs. The ACA’s FTET wedges vary substantially across groups: they are most significant for young and uneducated workers and least significant for the elderly. From an aggregate point of view the employer penalty by itself is historically significant, but nonetheless the wedges that they create are matched, if not exceeded, by the ACA’s implicit FTET. My results account for the facts that a variety of longstanding tax and subsidy rules also affect work incentives (in both directions) and that many people will not participate in programs for which they are eligible.

Although this paper does not even attempt to discuss all of the parts of the ACA that relate to the labor market or to taxation, its begins with an overview of the ACA’s main components related to insurance coverage. explains how two of those components contain taxes on full-time employment and represents the taxes in terms of household budget constraints. discusses determinants of the magnitude of those taxes. has the main results on the distribution of the ACA’s FTET across workers. discusses some of the behavioral effects of FTETs, and concludes

We use a panel data set of US tax records spanning 2008–2012 to study the impact of the Affordable Care Act (ACA) requirement to allow young adult dependents to be covered by their parents’ insurance policies on labor market-related outcomes. How health insurance expansions affect young adults through employment and education have important implications for public finance. Since tax data record access to employer-provided fringe benefits on W-2 forms, we are able to examine the impact of this coverage expansion by comparing young adults whose parents have access to benefits to other similar-aged young adults, before and after the law, and to young adults who are slightly older than the age threshold of the law. The use of tax data to identify families who have fringe benefits through their employer is an important advantage because the law was implemented during a labor market recovery in which outcomes could differ by age, even absent the law. Despite sizable increases documented elsewhere in insurance coverage resulting from this law, we find no meaningful changes in labor market-related outcomes. We examine a comprehensive set of outcomes (including measures of employment status, job characteristics, and postsecondary education), and are the first to use a triple-difference strategy to examine labor market effects of this law; we are also the first we know of to use tax data to examine the impact of the ACA on labor market outcomes. Although it is possible that labor market outcomes have changed in ways not captured by tax data (e.g., a change in hours of work while holding total wages constant, or a change in nonreported self-employment), our evidence suggests that the extension of health insurance to young adults did not substantially alter their labor market outcomes thus far.

A central justification for social insurance and for other policies aimed at retirement savings is that individuals may fail to make adequate provision during their working years. Much research has focused on myopia and other behavioral limitations. Yet little attention has been devoted to how these infirmities, and government policies to rectify them, influence labor supply. This linkage could be extremely important in light of the large preexisting distortion due to income and consumption taxation and income-based transfer programs. For example, might myopic individuals, as a first approximation, view payroll taxes and other withholding to fund retirement savings as akin to an income tax, while largely ignoring the distant future retirement benefits that they fund? If so, the distortion of labor supply may be many times higher than otherwise, making savings-promotion policies much more costly than appreciated. Or consider what may be the labor supply implications for an individual who is defaulted into higher savings and, as a consequence, sees concomitantly lower take-home pay. This essay offers a preliminary, conceptual exploration of these questions. In most of the cases considered, savings policies do not act purely like a tax despite individuals’ nonoptimizing savings behavior, and in some cases labor supply actually is raised, not lowered, in which event policies that boost savings may be significantly more welfare-enhancing than recognized. Accordingly, there is a compelling need for empirical exploration of the interaction between nonoptimal savings behavior and labor supply.