Tax Policy and the Economy

NBER Reporter: Fall 2000

Tax Policy and the Economy

The NBER's fifteenth Annual Conference on Tax Policy and Economy was held in Washington, D.C., on October 3. James M. Poterba, Director of the NBER's Public Economics Program, also of MIT, organized this program:

Mihir A. Desai, NBER and Harvard University, and James R. Hines, Jr., NBER and University of Michigan, "The Uneasy Marriage of Export Subsidies and the Income Tax"

Robert Carroll, Department of the Treasury, Douglas Holtz-Eakin, NBER and Syracuse University, Mark Rider, Kennesaw State University, and Harvey S. Rosen, NBER and Princeton University, "Personal Income Taxes and the Growth of Small Firms" (NBER Working Paper No. 7980)

Andrew W. Mitrusi, NBER, and James M. Poterba, "The Changing Importance of Income and Payroll Taxes on U.S. Families"

David T. Ellwood and Jeffrey B. Liebman, NBER and Harvard University, "The Middle Class Parent Penalty: Child Benefits in the U.S. Tax Code"

Martin Feldstein, NBER and Harvard University, and Elena Ranguelova, Harvard University, "Accumulated Pension Collars: A Market Approach to Reducing the Risk of Investment-Based Social Security Reform" (NBER Working Paper No. 7861)

Mark B. McClellan, NBER and Stanford University, "Medicare and the Federal Budget: Past Experience, Current Policy, Future Prospects"

Desai and Hines investigate the economic impact of tax subsidies to American exporters, including a partial tax exemption for export profits (available by routing exports through Foreign Sales Corporations) and the allocation of export profits to foreign source income for the purposes of U.S. taxation. The authors identify three important economic features of these tax provisions. First, the official figures appear to understate the tax expenditures associated with some U.S. export incentives by at least 65 percent. Second, the 1984 regime shift in export subsidies was contemporaneous with a significant change in the pattern of U.S. exports. The changes introduced in 1984 reduced manufacturing exports by an estimated 3.1 percent. Third, there were significant market reactions to the European Union's 1997 charge that U.S. export subsidies were inconsistent with World Trade Organization rules. The filing of the European complaint coincided with a 0.1 percent fall in the value of the U.S. dollar and steep drops in the share prices of large American exporters.

Carroll, Holtz-Eakin, Rider, and Rosen analyze the personal income tax returns of a large number of sole proprietors before and after the Tax Reform Act of 1986 in order to determine how the substantial reductions in marginal tax rates associated with that law affected the growth of their firms as measured by gross receipts. The authors find that individual income taxes exert a statistically and quantitatively significant influence on firm growth rates. Raising the sole proprietor's tax price (one minus the marginal tax rate) by 10 percent increases receipts by about 8.4 percent. This is consistent with the view that raising income tax rates discourages the growth of small businesses.

Nearly two-thirds of U.S. families currently pay more in payroll taxes than they pay in federal personal income taxes. At the bottom of the family income distribution, payroll taxes exceed income taxes for nearly 90 percent of families. Mitrusi and Poterba document the relative magnitude of income and payroll tax burdens on different types of families, including married couples, single individuals, and single-parent families. They conclude that the percentage of families for whom the marginal payroll tax rate exceeds the marginal personal income tax rate is much lower when the payroll tax rate is viewed net of the present discounted value of future Social Security benefits than when the statutory payroll tax rate alone is considered.

Low-income families with children receive large tax benefits from the Earned Income Tax Credit, while high-income taxpayers receive large tax benefits from dependent exemptions (of greatest value to those in high tax brackets). Middle-income parents, in contrast, receive substantially smaller tax benefits associated with children. This U-shaped pattern of benefits by income, which Ellwood and Liebman call the "middle-class parent penalty," not only raises issues of fairness, it also generates high or higher marginal tax rates and marriage penalties for moderate income families than for more well-to-do taxpayers. The authors examine five options for reducing or eliminating the middle-class parent penalty, and the high marginal tax rates and marriage penalties it produces.

Feldstein and Ranguelova show how a new type of derivative product that could be supplied by private financial markets might be used to guarantee that an investment-based Social Security reform provides at least the level of real retirement income that is projected in current Social Security rules. In effect, future retirees could purchase a "put option" that guarantees that future retirement benefits will not fall below the level projected in current Social Security law or some other chosen level. To pay for this guarantee, future retirees would agree to give up the part of the annuity payments that exceed a given level, effectively selling a "call option" on the stream of payments. This market-based approach could be completely voluntary, leaving individuals to decide what level of guarantee they want. The higher the minimum guarantee that individuals choose, the more of the potentially higher returns they must give up. The financial market thus can tailor individuals' products to their risk preferences. The authors show that it is feasible to protect future benefits equal to those projected in current law with a combination of the current payroll tax rate and Personal Retirement Account savings equal to 2.5 percent of covered earnings.

McClellan presents a primer on Medicare budgeting and uses this framework to discuss the accounting and real effects of recent proposed reforms in Medicare financing. He reviews Medicare's current financing system, describes the budgetary history of the program, and discusses the very challenging problem of uncertainty in budgetary forecasts attributable to having to estimate future population demographics, population health, and the intensity of medical care for future Medicare. His alternative forecasts of Medicare spending allow for higher trends in the intensity of medical treatment, which seem plausible given Medicare's historical record and continuing rapid technological innovation in care for the elderly. These forecasts suggest quite different budgetary implications from official forecasts. Finally, McClellan discusses the possible short- and long-term budgetary effects of a range of "accounting" and "real" reforms in the Medicare program.

These papers will be published by the MIT Press as Tax Policy and the Economy, Volume 15. The volume will be available in the spring. The conference versions of the papers are available at Books in Progress.

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