It's Time to End the Preference and Tax Capital Gains as Ordinary Income

The United States entered the COVID-19 crisis with an unusually large budget deficit for an economy at or close to full employment. Even if employment, output, and growth were to recover quickly to where they were at the end of 2019 (something that is far from certain), the deficit, under current law, will remain large.

The good news is that interest rates are likely to remain well below the rate of GDP growth for the foreseeable future, as they have since the beginning of the century. As long as that remains the case, there is no danger of an “exploding debt” scenario in which a large but constant federal deficit causes debt to grow without limit as a share of GDP. At this point, the greatest danger to the recovery is premature austerity. Still, as the recovery proceeds, we are sure to hear it argued on both economic and political grounds that the deficit should be reduced.

At that point, the search will be on for ways to close the budget gap. Although everyone will roll out their favorite spending cuts, much of the heavy lifting is going to have to come on the revenue side of the budget. As former Trump adviser Gary Cohn put it recently, talking to CNN’s Fareed Zakaria,

Our next Congress, the Congress that sits down in 2021, almost has to sit down and look at our spending and our revenue side. … How we spend money? There are a lot of places where we could cut back. In addition to that, I think they have to look at our tax system and think of ways that we raise revenue.

No area of the tax code is more ripe for reform than the preferential treatment given to capital gains. While incomes from wages and salaries face a maximum tax rate of 37 percent, capital gains on assets held for more than a year, in most cases, are taxed at a maximum rate of just 20 percent.

The benefits of the capital gains tax preference flow predominantly to the rich. Some 70 percent of the benefits go to taxpayers with annual incomes of $1 million or more, who enjoy annual benefits of $145,000 each. Benefits for households with incomes of $50,000 or less average about $10. For years, backers have tried to find broader justifications for this tax break, contending that benefits to the few somehow trickle down to the rest, but their efforts are less than convincing.

Here are some of the many issues raised by the capital gains tax preference, and the many reasons why its elimination should be at the top of the list in the search for additional sources of federal revenue.

How Household Debt Threatens the Recovery

The COVID-19 pandemic is having a disproportionate impact on the health of low-income Americans, but even those low-wage workers who avoid the disease itself are likely to suffer grave economic distress. 

In part, that is because workers with lower incomes have been more likely to lose their jobs than those who are better paid. The Pew Research Center reports that 32 percent of upper-income adults say that someone in their family has lost a job or taken a pay cut due to the outbreak. That compares with 42 percent of middle-income households who report lost jobs or pay cuts, and 52 percent of low-income households.

But pay is only part of the story. To fully understand the disparate economic impact of the pandemic, we need to look also at household wealth, or more exactly, net worth. The margin by which assets exceed household liabilities is crucial to a household’s ability to weather a job loss or a pay cut without catastrophic effects. And household net worth is not only less equally distributed than income — it is also frighteningly fragile for those in the bottom half of the population. That fragility is a major threat to hopes for a speedy economic recovery, as we will see.

COVID Pandemic Highlights Need for Reform of US Healthcare

The COVID-19 pandemic has highlighted longstanding weaknesses of the U.S. healthcare system. In a May 20 webinar sponsored by the Niskanen Center, I examined three key issues:

• Where has our healthcare system failed?
• What can be done to make it work better?
• Is healthcare reform as we know it even relevant any more?

By "healthcare reform as we know it," I mean the kinds of reforms discussed endlessly during 2019 Democratic primary campaign and before that, during Republican efforts to "repeal and replace" the Affordable Care Act. I highlight three reform models:

• Democratic candidate Joe Biden's proposal to expand Obamacare
• Republican Representative Bruce Westerman's Fair Care Act
• Universal catastrophic coverage, a nonpartisan alternative put forth by Niskanen Center.

I explain how each of these can at least partially address problems raised by the pandemic, including loss of employer-sponsored coverage by tens of millions of job-losers and inadequate provision for testing, treatment, and supported isolation. I also discuss some problems that existing reforms do not adequately address.

My slideshow from the webinar is available here. A link to the complete video, including comments by Jeff Flier and additional Q&A by participants, will be available soon. 

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A Social Safety Net for the Pandemic and Beyond

America's social safety net has been severely strained by the COVID-19 pandemic. Although the virus has affected people in all walks of life, the burden of illness and lost jobs has fallen most heavily on people in the lower half of the income distribution.

As the chart shows, those in the bottom half are the households whose financial condition is most fragile. They suffered the greatest economic harm in the 2008 financial crisis. Unlike their wealthier peers, they have not yet recovered, and they will experience even greater financial stress this time.

To cope with the economic effects of the pandemic, we need a social safety net that is fast, fair, and work-friendly. Federal efforts to provide income support in this crisis are commendable, but they have not reached everyone in timely fashion, and they have often been poorly targeted.

The safety net needs top-to-bottom reform. A reformed system would place more emphasis on cash assistance, with less in-kind and means-tested welfare. It would be "always on" in the sense that everyone would be automatically pre-enrolled for the minimum level of support needed in good times, so that aid could be quickly ramped up when a crisis strikes. It would provide adequate pay for essential workers and encourage others to return to work when the crisis has passed.

All of this and more was discussed in a webinar presented jointly by the Niskanen Center and the Center for Ethics, Economics, and Public Policy at the University of San Diego on May 14, 2020. You can view a slideshow presented during the webinar at this link or watch a complete video of the webinar, including Q&A, here.

Ozzie Zehner is at it again: Green Illusions, and Planet of the Humans

Are solar, wind, and other alternatives the magic bullets that will solve the world’s environmental and energy problems? Take a closer look, wrote Ozzie Zehner in his 2012 book,  Green Illusions. He is still saying much the same thing, in a new movie, Planet of the Humans, despite the great strides renewables have made in the past eight years.

My Niskanen Center colleague Nader Sobhani has reviewed the movie, and finds it wanting. I'll let you read his movie review. Here is a repost my own 2012 review of the book:

Zehner not only argues that green energy has technological, environmental and economic limits, but also that without an appropriate policy context, some forms of alternative energy could do more harm than good.

The dirty secrets of clean energy

The first part of Zehner’s book—by far the best—is devoted to explaining why neither photovoltaic, nor wind, nor biomass, nor any of the other alternatives to fossil fuels will be able to deliver a future of abundant, cheap, clean energy. Chapter by chapter, he brings out the environmental and economic limitations of each technology. Among the highlights—

COVID-Related Spending Must Not Become an Excuse for a Post-Crisis Fiscal Straitjacket

Writing for the Brookings Up Front blog, Stuart Butler and Timothy Higashi urge fiscal policymakers to look beyond the current crisis. Extraordinary short-term spending is justified, they agree, but, they urge that “we also need to put in place – ideally as part of ongoing stimulus measures – procedures that will help policymakers and the public to prepare for the less urgent but equally important task of managing the future fiscal and economic threats from today’s emergency actions.”

They are right that we need better long-term fiscal rules to avoid long-term budget chaos. Even more importantly, we need good rules to avoid premature austerity that could slow the recovery, as happened half-way through the rebound from the 2008 financial crisis. But just what should the rules look like?

Above all, in my view, any such rules must not become a fiscal straitjacket that would impair our prosperity for years to come. The once-popular notion of a balanced budget amendment is a classic example of what we do not need. A rule requiring annual budget balance would be profoundly procyclical. It would require cutting expenditures when tax revenues fell during a slump, and in boom times, it would put no real constraint on tax giveaways like the 2017 Tax Cuts and Jobs Act.

No one seems to be pushing a balanced budget amendment now, but some ideas that are floating around would not be much better. One example is the Enzi-Whitehouse plan (S.2765), which Butler and Higashi are a good deal warmer toward than I am. As I read it, the central pillar of the Enzi-Whitehouse plan is a hard cap on the debt-to-GDP ratio that could be overcome only by a supermajority. Unless the bill were very carefully crafted, it would become a de-facto balanced budget requirement as soon as the debt ceiling were reached, which it inevitably would be. If the current draft of the bill contains safeguards to keep that from happening, I can’t spot them in the text.

Tired of the COVID-19 Lockdown? Here is a Responsible Reopening Plan

People are getting tired of the COVID-19 lockdown. Surveys show that a majority still put a greater priority on protecting public health than on reopening the economy, but either way, we would all prefer to do both. A plan released yesterday from the Harvard-based Safra Center for Ethics shows that is possible, if we are willing to take the necessary steps.

The Roadmap for Pandemic Resilience (“The Roadmap,” in what follows) is not the first try at finding a way to safely reopen the economy, but it outclasses all previous attempts with its a realistic timetable, fact-based quantitative benchmarks, and a detailed institutional structure. By comparison, the vague guidelines offered by the White House are little more than slogans and aspirations. Here are the key features that distinguish The Roadmap from other reopening plans:

Testing. The White House talks of expanding testing from its current rate of 150,000 or so a day to 300,000. That is barely enough to test people who have severe symptoms, let alone enough to test nonsymptomatic essential workers to make sure they do not spread the virus or to conduct the random surveillance testing we need to know exactly where the virus is (and is not) in our communities. The Roadmap calls for 2 million tests a day, quickly rising to 5 million. Sound like a lot? Those numbers fall only in the middle of a range of credible testing estimates reviewed by the Kaiser Family Foundation, but they are enough if the right people are tested at the right times.