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August 04, 2011

How To Cut $1 Trillion a Year

It's tough, and it involves a lot of things that are virtually impossible, like zeroing out education costs, but this is the rough outline of what must be done.

It won't be pretty and it won't be popular. Here are the first 8 items, out of 20:

1. Social Security: Yeah, they’ll say you’re throwing Granny off the cliff. But it’s her or the grandkids. So implement aggressive means-testing and other reforms to cut 20 percent of spending for $150 billion in savings.

2. Medicare: Ditto, for $100 billion in savings.

3. Keep on going and reduce Medicaid and other health-care services spending by 10 percent: $33 billion.

4. National defense: Republicans will howl, but there’s room for a 10 percent cut to all national-defense spending, including non-DoD activities such as DoE’s work maintaining our nuclear arsenal. That nets $74 billion in savings. Surely we can slaughter hapless desert barbarians more cheaply.

5. “Other income security.” That’s the welfare state bits and pieces not included in Medicare, Medicaid, Social Security, food stamps, etc. Welfare of the checks-from-Uncle variety. Eliminating it entirely saves $159 billion.

6. Welfare for bureaucrats: Making federal-employee retirement and disability systems totally self-funding saves $123 billion.

7. Eliminate federal education spending entirely: elementary, secondary, and higher-ed. Leaving it to the states and to the market saves us $106 billion. Harvard will figure something out.

8. Eliminate “community and regional-development” spending, a.k.a. boondoogles and slush funds, except for disaster relief: $15 billion.

Williamson's plan involves essentially ending all federal welfare spending, which is almost impossible to contemplate. Which, in turn, should give an idea of how difficult this is, and how large a hole we're in.

One of Williamson's suggestions -- and he doesn't even include this in getting to his trillion; this is bonus -- is ending the home mortgage interest deduction.

He suggests that this is a distorting social-engineering intervention in the tax code, a boondoggle, a pander to home owners.

Honestly, that's what I always thought it was, myself. But Richard Epstein writes that there is a good conceptual reason why this deduction exists.

The root of the difficulty is this: it is not all that easy to figure out which downward adjustment in taxable income counts as a tax expenditure, and which does not. Right now the current income tax system starts with gross income, a number that is then reduced in various ways to get an "adjusted gross income" figure, which is the normal taxable base.

For example, an ordinary business deduction for inventory reduces the amount of taxable income, but no one thinks of that deduction as a tax expenditure. Why? The proper economic definition of taxable income must subtract out, from the revenues received, the expenses incurred to obtain the gross receipts. To recognize the income but to disallow the deduction makes taxation punitive, thereby unwisely discouraging individuals to invest in socially productive activities by forcing them to pay taxes on a nonexistent economic gain.

Isolating tax expenditures, therefore, requires a strong understanding that the best definition of income is: appreciation in net worth plus consumption during the relevant tax period. Once that is done, the next task is to look for some administrative justification for not taxing certain kinds of income.

...

One clear case of a tax expenditure is the interest deduction on a home mortgage. There is no question that interest payments count as expenditures, and thus a reduction to gross revenues. But that expenditure is offset, not quite perfectly, by the consumption value of the home purchased with a home mortgage.

A precise economic test would first allow the interest deduction but bring the imputed income attributable from home use into the system, even though it is not a receipt of any kind. But since calculating that imputed income is too costly, the law should follow the simpler rule that treats the consumption enjoyed as a perfect income offset to the interest deduction. In fact in most cases, the consumption value of the home is probably greater than the interest payments on the loan, especially toward the end of the life of the mortgage. Nonetheless, that excess imputed income goes untaxed, because of the insoluble difficulties of its direct measure.

I'm not sure I understand that. Or rather, I understand that, but what I'm missing is why he says this should be treated like a business expense.

It's not a business expense, deducted from net income, to find actual profit.

It's a living expense. Those who rent don't subtract their rent payments from their income. No one subtracts their food costs from their income. 90% of the country needs a car for purposes of moving to and from their place of work, but no one suggests car ownership interest should be deducted from net income and hence immune to tax.

I'm not sure I understand why he's saying that in the case of this incurred living expense, the cost of owning one's dwelling, a taxpayer should deduct that expense from his net income for purposes of finding taxable income.

Maybe I'm just slow. Or maybe he didn't explain it well enough.

He has a good quote in here, which Mr. Obama should ponder:

Political forces cannot redistribute the wealth that the economic system does not produce.

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posted by Ace at 01:06 PM

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