A Carbon Tax with Redistribution Would Be a Significant Help to the Poor

A.  Introduction

Economists have long recommended taxing pollution as an effective as well as efficient way to achieve societal aims to counter that pollution.  What is commonly called a “carbon tax”, but which in fact would apply to all emissions of greenhouse gases (where carbon dioxide, CO2, is the largest contributor), would do this.  “Cap and trade” schemes, where polluters are required to acquire and pay for a limited number of permits, act similarly.  The prime example in the US of such a cap and trade scheme was the program to sharply reduce the sulfur dioxide (SO2) pollution from the burning of coal in power plants.  That program was launched in 1995 and was a major success.  Not only did the benefits exceed the costs by a factor of 14 to 1 (with some estimates even higher – as much as 100 to 1), but the cost of achieving that SO2 reduction was only one-half to one-quarter of what officials expected it would have cost had they followed the traditional regulatory approach.

Cost savings of half or three-quarters are not something to sneer at.  Reducing greenhouse gas emissions, which is quite possibly the greatest challenge of our times, will be expensive.  The benefits will be far greater, so it is certainly worthwhile to incur those expenses (and it is just silly to argue that “we cannot afford it” – the benefits far exceed the costs).  One should, however, still want to minimize those costs.

But while such cost savings are hugely important, one should also not ignore the distributional consequences of any such plan.  These are a concern of many, and rightly so.  The poor should not be harmed, both because they are poor and because their modest consumption is not the primary cause of the pollution problem we are facing.  But this is where there has been a good deal of confusion and misunderstanding.  A tax on all greenhouse gas emissions, with the revenue thus generated then distributed back to all on an equal per capita basis, would be significantly beneficial to the poor in purely financial terms.  Indeed it would be beneficial to most of the population since it is a minority of the population (mostly those who are far better off financially than most) who account for a disproportionate share of emissions.

A specific carbon tax plan that would work in this way was discussed in an earlier post on this blog.  I would refer the reader to that earlier post for the details on that plan.  But briefly, under this proposal all emissions of greenhouse gases (not simply from power plants, but from all sources) would pay a tax of $49 per metric ton of CO2 (or per ton of CO2 equivalent for other greenhouse gases, such as methane).  A fee of $49 per metric ton would be equivalent to about $44.50 per common ton (2,000 pounds, as commonly used in the US but nowhere else in the world).  The revenues thus generated would then be distributed back, in full, to the entire population in equal per capita terms, on a monthly or quarterly basis.  There would also be a border-tax adjustment on goods imported, which would create the incentive for other countries to join in such a scheme (as the US would charge the same carbon tax on such goods when the source country hadn’t, but with those revenues then distributed to Americans).

The US Treasury published a study of this scheme in January 2017, and estimated that such a tax would generate $194 billion of revenues in its initial year (which was assumed to be 2019).  This would allow for a distribution of $583 to every American (man, woman, and child – not just adults).  Furthermore, the authors estimated what the impact would be by family income decile, and concluded that the bottom 7 deciles of families (the bottom 70%, as ranked by income) would enjoy a net benefit, while only the richest 30% would pay a net cost.

That distributional impact will be the focus of this blog post.  It has not received sufficient attention in the discussion on how to address climate change.  While the Treasury study did provide estimates on what the impacts by income decile would be (although not always in an easy to understand form), views on a carbon tax often appear to assume, incorrectly, that the poor will pay the most as a share of their income, while the rich will be able to get away with avoiding the tax.  The impact would in fact be the opposite.  Indeed, while the primary aim of the program is, and should be, the reduction of greenhouse gas emissions, its redistributive benefits are such that on that basis alone the program would have much to commend it.  It would also be just.  As noted above, the poor do not account for a disproportionate share of greenhouse gas emissions – the rich do – yet the poor suffer similarly, if not greater, from the consequences.

This blog post will first review those estimated net cash benefits by family income decile, both in dollar amounts and as a share of income.  To give a sense of how important this is in magnitude, it will then examine how these net benefits compare to the most important current cash transfer program in the US – food stamp benefits.  Finally, it will briefly review the politics of such a program.  Perceptions have, unfortunately, been adverse, and many pundits believe a carbon tax program would never be approved.  Perhaps this might change if news sources paid greater attention to the distribution and economic justice benefits.

B.  Net Benefits or Costs by Family Income Decile from a Carbon Tax with Redistribution

The chart at the top of this post shows what the average net impact would be in dollars per person, by family cash income decile, if a carbon tax of $49 per metric ton were charged with the revenues then distributed on an equal per capita basis.  While prices of energy and other goods whose production or use leads to greenhouse gas emissions would rise, the revenues from the tax thus generated would go back in full to the population.  Those groups who account for a less than proportionate share of greenhouse gas emissions (the poor and much of the middle class) would come out ahead, while those with the income and lifestyle that lead to a greater than average share of greenhouse gas emissions (the rich) will end up paying in more.

The figures are derived from estimates made by the staff of the US Treasury – staff that regularly undertake assessments of the incidence across income groups of various tax proposals.  The study was published in January 2017, and the estimates are of what the impacts would have been had the tax been in place for 2019.  The results were presented in tables following a standard format for such tax incidence studies, with the dollars per person impact of the chart above derived from those tables.

To arrive at these estimates, the Treasury staff first calculated what the impact of such a $49 per metric ton carbon tax would be on the prices of goods.  Such a tax would, for example, raise the price of gasoline by $0.44 per gallon based on the CO2 emitted in its production and when it is burned.  Using standard input-output tables they could then estimate what the price changes would be on a comprehensive set of goods, and based on historic consumption patterns work out what the impacts would be on households by income decile.  The net impact would then follow from distributing back on an equal per capita basis the revenues collected by the tax.  For 2019, the Treasury staff estimated $194 billion would be collected (a bit less than 1% of GDP), which would allow for a transfer back of $583 per person.

Those in the poorest 10% of households would receive an estimated $535 net benefit per person from such a scheme.  The cost of the goods they consume would go up by $48 per person over the course of a year, but they would receive back $583.  They do not account for a major share of greenhouse gas emissions because they cannot afford to consume much.  They are poor, and a family earning, say, $20,000 a year consumes far less of everything than a family earning $200,000 a year.  In terms of greenhouse gas emissions implicit in the Treasury numbers, the poorest 10% of Americans account only for a bit less than 1.0 metric tons of CO2 emissions per person per year (including the CO2 equivalent in other greenhouse gases).  The richest 10% account for close to 36 tons CO2 equivalent per person per year.

As one goes from the lower income deciles to the higher, consumption rises and CO2 emissions from the goods consumed rises.  But it is not a linear trend by decile.  Rather, higher-income households account for a more than proportionate share of greenhouse gas emissions.  As a consequence, the break-even point is not at the 50th percentile of households (as it would be if the trend were linear), but rather something higher.  In the Treasury estimates, households up through the 70th percentile (the 7th decile) would on average still come out ahead.  Only the top three deciles (the richest 30%) would end up paying more for the carbon tax than what they would receive back.  But this is simply because they account for a disproportionately high share of greenhouse gas emissions.  It is fully warranted and just that they should pay more for the pollution they cause.

But it is also worth noting that while the richer household would pay more in dollar terms than they receive back, those higher dollar amounts are modest when taken as a share of their high incomes:

In dollar terms the richest 10% would pay in a net $1,166 per person in this scheme, as per the chart at the top of this post.  But this would be just 1.0% of their per-person incomes.  The 9th decile (families in the 80 to 90th percentile) would pay in a net of 0.7% of their incomes, and the 8th decile would pay in a net of 0.3%. At the other end of the distribution, the poorest 10% (the 1st decile) would receive a net benefit equal to 8.9% of their incomes.  This is not minor.  The relatively modest (as a share of incomes) net transfers from the higher-income households permit a quite substantial rise (in percentage terms) in the incomes of poorer households.

C.  A Comparison to Transfers in the Food Stamps Program

The food stamps program (formally now called SNAP, for Supplemental Nutrition Assistance Program) is the largest cash income transfer program in the US designed specifically to assist the poor.  (While the cost of Medicaid is higher, those payments are made directly to health care providers for their medical services to the poor.)  How would the net transfers under a carbon tax with redistribution compare to SNAP?  Are they in the same ballpark?

I had expected they would not be close.  However, it turns out that they are not that far apart.  While food stamps would still provide a greater transfer for the very poorest households, the supplement to income that those households would receive by such a carbon tax scheme would be significant.  Furthermore, the carbon tax scheme would be of greater benefit than food stamps are, on average, for lower middle-class households (those in the 3rd decile and above).

The Congressional Budget Office (CBO) has estimated how food stamp (SNAP) benefits are distributed by household income decile.  While the forecast year is different (2016 for SNAP vs. 2019 for the carbon tax), for the purposes here the comparison is close enough.  From the CBO figures one can work out the annual net benefits per person under SNAP for households in the 1st to 4th deciles (with the 5th through the 10th deciles then aggregated by the CBO, as they were all small):

The average annual benefits from SNAP were estimated to be about $1,500 per person for households in the poorest decile and $690 per person in the 2nd decile.  These are larger than the estimated net benefits of these two groups under a carbon tax program (of $535 and $464 per person, respectively), but it was surprising, at least to me, that they are as close as they are.  The food stamp program is specifically targeted to assist the poor to purchase the food that they need.  A carbon tax with redistribution program is aimed at cutting back greenhouse gas emissions, with the funds generated then distributed back to households on an equal per capita basis.  They have very different aims, but the redistribution under each is significant.

D.  But the Current Politics of Such a Program Are Not Favorable

A carbon tax with redistribution program would therefore not only reduce greenhouse gas emissions at a lower cost than traditional approaches, but would also provide for an equitable redistribution from those who account for a disproportionate share of greenhouse gas emissions (the rich) to those who do not (the poor).  But news reporters and political pundits, including those who are personally in favor of such a program, consider it politically impossible.  And in what was supposed to be a personal email, but which was part of those obtained by Russian government hackers and then released via WikiLeaks in order to assist the Trump presidential campaign, John Podesta, the senior campaign manager for Hillary Clinton, wrote:  “We have done extensive polling on a carbon tax.  It all sucks.”

Published polls indicate that the degree of support or not for a carbon tax program depends critically on how the question is worded.  If the question is stated as something such as “Would you be in favor of taxing corporations based on their carbon emissions”, polls have found two-thirds or more of Americans in support.  But if the question is worded as something such as “Would you be in favor of paying a carbon tax on the goods you purchase”, the support is less (often still more than a majority, depending on the specific poll, but less than two-thirds).  But they really amount to the same thing.

There are various reasons for this, starting with that the issue is a complex one, is not well understood, and hence opinions can be easily influenced based on how the issue is framed.  This opens the field to well-funded vested interests (such as the fossil fuel companies) being able to influence votes by sophisticated advertising.  Opponents were able to outspend proponents by 2 to 1 in Washington State in 2018, when a referendum on a proposed carbon tax was defeated (as it had been also in 2016).  Political scientists who have studied the two Washington State referenda believe they would be similarly defeated elsewhere.

There appear to be two main concerns:  The first is that “a carbon tax will hurt the poor”.  But as examined above, the opposite would be the case.  The poor would very much benefit, as their low consumption only accounts for a small share of carbon emissions (they are poor, and do not consume much of anything), but they would receive an equal per capita share of the revenues raised.

In distinct contrast, but often not recognized, a program to reduce greenhouse gas emissions based on traditional regulation would still see an increase in costs (and indeed likely by much more, as noted above), but with no compensation for the poor.  The poor would then definitely lose.  There may then be calls to add on a layer of special subsidies to compensate the poor, but these rarely work well.

The second concern often heard is that “a carbon tax is just a nudge” and in the end will not get greenhouse gas emissions down.  There may also be the view (internally inconsistent, but still held) that the rich are so rich that they will not cut back on their consumption of high carbon-emission goods despite the tax, while at the same time the rich can switch their consumption (by buying an electric car, for example, to replace their gasoline one) while the poor cannot.

But the prices do matter.  As noted at the start of this post, the experience with the cap and trade program for SO2 from the burning of coal (where a price is put on the SO2 emissions) found it to be highly effective in bringing SO2 emissions down quickly.  Or as was discussed in an earlier post on this blog, charging polluters for their emissions would be key to getting utilities to switch use to clean energy sources.  The cost of both solar and wind new generation power capacity has come down sharply over the past decade, to the point where, for new capacity, they are the cheapest sources available.  But this is for new generation.  When there is no charge for the greenhouse gases emitted, it is still cheaper to keep burning gas and often coal in existing plants, as the up-front capital costs have already been incurred and do not affect the decision of what to use for current generation.  But as estimated in that earlier post, if those plants were charged $40 per ton for their CO2 emissions, it would be cheaper for the power utilities to build new solar or wind plants and use these to replace existing fossil fuel plants.

There are many other substitution possibilities as well, but many may not be well known when the focus is on a particular sector.  For example, livestock account for about 30% of methane emissions resulting from human activity.  This is roughly the same share as methane emissions from the production and distribution of fossil fuels.  And methane is a particularly potent greenhouse gas, with 86 times the global warming potential over a 20-year horizon of an equal weight of CO2.  Yet a simple modification of the diets of cows will reduce their methane emissions (due to their digestive system – methane comes out as burps and farts) by 33%.  One simply needs to add to their feed just 100 grams of lemongrass per day and the digestive chemistry changes to produce far less methane.  Burger King will now start to purchase its beef from such sources.

This is a simple and inexpensive change, yet one that is being done only by Burger King and a few others in order to gain favorable publicity.  But a tax on such greenhouse gas emissions would induce such an adjustment to the diets of livestock more broadly (as well as research on other dietary changes, that might lead to an even greater reduction in methane emissions).  A regulatory focus on emissions from power plants alone would not see this.  One might argue that a broader regulatory system would cover emissions from such agricultural practices, and in principle it should.  But there has been little discussion of extending the regulation of greenhouse gas emissions to the agricultural sector.

More fundamentally, regulations are set and then kept fixed over time in order to permit those who are regulated to work out and then implement plans to comply.  Such systems are not good, by their nature, at handling innovations, as by definition innovations are not foreseen.  Yet innovations are precisely what one should want to encourage, and indeed the ex-post assessment of the SO2 emissions trading program found that it was innovations that led to costs being far lower than had been anticipated.  A carbon tax program would similarly encourage innovations, while regulatory schemes can not handle them well.

There may well be other concerns, including ones left unstated.  Individuals may feel, for example, that while climate change is indeed a major issue and needs to be addressed, and that redistribution under a carbon tax program might well be equitable overall, that they will nonetheless lose.  And some will.  Those who account for a disproportionately high share of greenhouse gas emissions through the goods they purchase will end up paying more.  But costs will also rise under the alternative of a regulatory approach (and indeed rise by a good deal more), which will affect them as well.  If they do indeed account for a disproportionately high share of greenhouse gas emissions, they should be especially in favor of an approach that would bring these emissions down at the lowest possible cost.  A scheme that puts a price on carbon emissions, such as in a carbon tax scheme, would do this at a lower cost than traditional approaches.

So while many have concerns with a carbon tax with redistribution scheme, much of this is due to a misunderstanding of what the impacts would be, as well as of what the impacts would be of alternatives.  One sees this in the range of responses to polling questions on such schemes, where the degree of support depends very much on how the questions are worded or framed.  There is a need to explain better how a carbon tax with redistribution program would work, and we have collectively (analysts, media, and politicians) failed to do this.

There are also some simple steps one can take which would likely increase the attractiveness of such a program.  For example, perceptions would likely be far better if the initial rebate checks were sent up-front, before the carbon taxes were first to go into effect, rather than later, at the end of whatever period is chosen.  Instead of households being asked to finance the higher costs over the period until they received their first rebate checks, one would have the government do this.  This would not only make sense financially (government can fund itself more cheaply than households can), but more important, politically.  Households would see up-front that they are, indeed, receiving a rebate check before the prices go up to reflect the carbon tax.

And one should not be too pessimistic.  While polling responses depend on the precise wording used, as noted above, the polling results still usually show a majority in support.  But the issue needs to be explained better.  There are problems, clearly, when issues such as the impact on the poor from such a scheme are so fundamentally misunderstood.

E.  Conclusion 

Charging for greenhouse gases emitted (a carbon tax), with the revenues collected then distributed back to the population on an equal per capita basis, would be both efficient (lower cost) and equitable.  Indeed, the transfers from those who account for an especially high share of greenhouse gas emissions (the rich) to those who account for very little of them (the poor), would provide a significant supplement to the incomes of the poor.  While the redistributive effect is not the primary aim of the program (reducing greenhouse gases is), that redistributive effect would be both beneficial and significant.  It should not be ignored.

The conventional wisdom, however, is that such a scheme could not command a majority in a referendum.  The issue is complex, and well-funded vested interests (the fossil fuel companies) have been able to use that complexity to propagate a sufficient level of concern to defeat such referenda.  The impact on the poor has in particular been misportrayed.

But climate change really does need to be addressed.  One should want to do this at the lowest possible cost while also in an equitable manner.  Hopefully, as more learn what carbon tax schemes can achieve, politicians will obtain the support they need to move forward with such a program.

The Performance of the Stock Market During Trump’s Term in Office: Not So Special

A.  Introduction

Stock market performance is often taken to be a good measure of how the economy as a whole is performing.  But it is not.  For most Americans it is simply irrelevant, as the overwhelming share of investments in the stock markets are held by only a small segment of the population (the wealthy).  And its track record as a broader indicator of how the economy is performing is imperfect at best.

Still, many do focus on stock market returns, and Trump brags that the performance of the market during his term in office has been spectacular.

That is not the case.  This post will look at how the stock market has performed during Trump’s term in office thus far, and compare it to what that performance was under presidents going back to Reagan up to the same point in their terms.

First, however, we will briefly discuss to what extent one should expect stock market prices to reflect actions a president might be taking.  And the answer is some, but there is much more going on.

B.  Presidential Policies and the Stock Market

Owning shares of a firm entitles the owner to a share of the profits generated by that firm, both now and into the future.  And while there are many complications, a simple metric commonly used to assess the price of a share in a firm, is the price/earnings ratio.  If earnings (profits) go up, now and into the future, then for a given price/earnings ratio the price of the stock would go up in proportion.

Economic policies affect profits.  And in a thriving economy, profits will also be rising.  The policies of a presidential administration will affect this, and although the link is far from a tight one (with important lags as well), policies that are good for the economy as a whole will generally also lead to a rising stock market.

But there is also a more specific link to policy.  What accrues to the shareholders are not overall profits, but profits after taxes.  And this changed significantly as a result of the new tax law pushed through Congress by Trump and the Republicans in December 2017.  It resulted in the effective corporate profits (income) tax being cut by more than half:

This chart is an update of one prepared for an earlier post on this blog (where one can see a further discussion of what lies behind it).  It shows corporate profit taxes at the federal level as a share of corporate profits (calculated from figures in the national income accounts issued by the BEA).  While Trump and the Republicans in Congress asserted the 2017 tax bill would not lead to lower corporate profit taxes being paid (as loopholes would be closed, they asserted), in fact they did.  And dramatically so, with the effective corporate tax rate being slashed by more than half –  from around 15 to 16% prior to 2017, to just 7% or so since the beginning of 2018 (and to just 6.3% most recently).

This cut therefore led to a significant increase in after-tax profits for any given level of before-tax profits, which has accrued to the shareholders.  Note that this would not be due to the corporations becoming more productive or efficient, but rather simply from taxing profits less and shifting the tax burden then on to others (i.e. a redistributive effect).  And based on a reduction in the taxes from 16% of corporate profits to 7%, after-tax profits would have gone from 84% of profits to 93%, an increase of about 11%.  For any given price/earnings ratio, one would then expect stock prices, for this reason alone, to have gone up by about 11%.

[Side note:  Technically one should include in this calculation also the impact of taxes on profits by other government entities – primarily those of state and local governments.  These have been flat at around 3 1/2% of profits, on average.  With these taxes included, after-tax profits rose from 80 1/2% of before-tax profits to 89 1/2%, an increase that is still 11% within round-off.]

One should therefore expect that stock prices following this tax cut (or in anticipation of it) would have been bumped up by an additional 11% above what they otherwise would have been.  Other things equal, the performance of the stock market under Trump should have looked especially good as a result of the shift in taxes away from corporations onto others.  But what has in fact happened?

C.  Trump vs. Obama

The chart at the top of this post compares the performance of the stock market during Trump’s term in office thus far (through December 31, 2019) to that under Obama to the same point in his first term in office.  The difference is clear.  Other than during Obama’s first few months in office, when he inherited from George W. Bush an economy in freefall, stock market performance under Obama was always better than it has been under Trump.  Even after slashing corporate profit taxes by more than half, the stock market under Trump did not do exceptionally well.

The S&P500 Index is being used as the measure of the US stock market.  Most professionals use this index as the best indicator of overall stock market performance, as it is comprehensive and broad (covering the 500 largest US companies as measured by stock market value, with the companies weighted in the index based on their market valuations).  The data were downloaded from Yahoo Finance, where it is conveniently available (with daily values for the index going back to 1927), but can be obtained from a number of sources.  The chart shows end-of-month figures, starting from December 31 of the month before inauguration, and going through to December 31 of their third year in office.  The index is scaled to 100.0 on exactly January 20 (with this presented as “month” 0.65).

So if one wants to claim “bragging rights” for which president saw a better stock market performance, Obama wins over Trump, at least so far in their respective terms.

D.  Trump vs. All Presidents Since Reagan

A comparison to just one president is limited.  How does the performance under Trump compare to that under other US presidents up to the same points in their terms in office?  Trump is roughly in the middle:

This chart tracks the performance under each president since Reagan up through the third year of their first terms in office.  I have adjusted here for inflation (using the CPI), as inflation was substantially higher during the Reagan and Bush Sr. terms in office than it has been since.  (I left the chart at the top of this post of just Obama vs. Trump in nominal terms as inflation in recent years has been steady and low.  But for those interested in the impact of this, one can see the Obama and Trump numbers in real terms in the current chart.)  I have included in this chart only the first terms of each president (with one exception) as the chart is already cluttered and was even more so when I had all the presidential terms.

The exception is that I included for perspective the stock market performance during Clinton’s second term in office.  The stock market rose over that period by close to 80% in real terms, which was substantially higher than under any other president since at least before Reagan in either their first or second terms.  The performance in Obama’s first term (of 146% in real terms) was the second-highest.  There was then a set of cases which, at the three-year mark, showed surprising uniformity in performance, with increases of between 32% and 34% in the second Reagan term, the first Clinton term, the second Obama term, and Trump’s term so far.  Bush Sr. was not far behind this set with an increase of 28%.

The worst performances were under Bush Jr. ( a fall of 22% to the third-year point in his first term), and Reagan (an increase of just 8% to that point in his first term).

So the performance of the market under Trump is in the middle – not the worst, but well below the best.

E.  Single Year Increases in the S&P500 from 1946 to 2019

Finally, was the increase under Trump in his best single year so far (2019) a record?  No, it was not.  Looking at the single year performances (in real terms) since 1946, the top 15 were:

The increase in 2019, of 25.9%, was good, but only the sixth-highest of the 74 years between 1946 and 2019 (inclusive).  The stock market rose by more in 2013 during Obama’s term in office (by 27.7%), and in 1997 (28.8%) and 1995 (30.8%) which were both Clinton years.  And the highest increases were in 1958 (35.7%) and 1954 (45.6%) when Eisenhower was president.

The market also rose substantially in 2017, in Trump’s first year in office, by 16.9%.  But it then fell by 8.0% in 2018, in Trump’s second year in office.  Overall, the average rank (out of the 74 years from 1946 to 2019) of the individual year performances over the three years Trump has been in office so far, would place Trump in the middle third.  Not the worst, but also far from the best.  And comparing the three-year average while Trump has been president to rolling three-year averages since 1946, Trump’s average (of 11.6%) is well below the best.  The highest was an average return of 25.3% in 1995-97 during Clinton’s term in office.  And the three-year average return was also higher at 16.7% in 2012-14 during Obama’s term.

F.  Summary and Conclusion

Trump likes to brag that the performance of the stock market during his term in office has been exceptional.  But despite a slashing of corporate profit taxes (which, other things being equal would be expected to increase stock prices by 11%), the performance of the market during Trump’s term in office would put him in the middle.  Specifically:

a)  The market rose by more during the first three years of Obama’s term in office than it has under Trump;

b)  Compared to the first three years in office of all presidents since Reagan (whether first terms only, or first and second terms) would place Trump in the middle.  Indeed, the increase under Trump so far was almost exactly the same as the increases seen (at the three-year point) in Obama’s second term, in Reagan’s second term, and in Clinton’s first term.  And the return under Trump was well below that seen in Obama’s first term, and especially far below that in Clinton’s second term.

c)  The individual year performances during Trump’s three years have also not been exceptional.  While the performance in 2019 was good, it was below that of a number of other years since World War II, and below that of individual years during Obama’s and Clinton’s terms in office.

But as noted at the start of this post, stock market returns should not be over-emphasized.  An increase in the stock market does little for those who do not have the wealth to have substantial holdings in the stock market, and as a broader indicator of how the overall economy is performing, stock market returns are imperfect at best.

Still, one should be accurate in one’s claims.  And as on many things, Trump has not been.

Andrew Yang’s Proposed $1,000 per Month Grant: Issues Raised in the Democratic Debate

A.  Introduction

This is the second in a series of posts on this blog addressing issues that have come up during the campaign of the candidates for the Democratic nomination for president, and which specifically came up in the October 15 Democratic debate.  As flagged in the previous blog post, one can find a transcript of the debate at the Washington Post website, and a video of the debate at the CNN website.

This post will address Andrew Yang’s proposal of a $1,000 per month grant for every adult American (which I will mostly refer to here as a $12,000 grant per year).  This policy is called a universal basic income (or UBI), and has been explored in a few other countries as well.  It has received increased attention in recent years, in part due to the sharp growth in income inequality in the US of recent decades, that began around 1980.  If properly designed, such a $12,000 grant per adult per year could mark a substantial redistribution of income.  But the degree of redistribution depends directly on how the funding would be raised.  As we will discuss below, Yang’s specific proposals for that are problematic.  There are also other issues with such a program which, even if well designed, calls into question whether it would be the best approach to addressing inequality.  All this will be discussed below.

First, however, it is useful to address two misconceptions that appear to be widespread.  One is that many appear to believe that the $12,000 per adult per year would not need to come from somewhere.  That is, everyone would receive it, but no one would have to provide the funds to pay for it.  That is not possible.  The economy produces so much, whatever is produced accrues as incomes to someone, and if one is to transfer some amount ($12,000 here) to each adult then the amounts so transferred will need to come from somewhere.  That is, this is a redistribution.  There is nothing wrong with a redistribution, if well designed, but it is not a magical creation of something out of nothing.

The other misconception, and asserted by Yang as the primary rationale for such a $12,000 per year grant, is that a “Fourth Industrial Revolution” is now underway which will lead to widespread structural unemployment due to automation.  This issue was addressed in the previous post on this blog, where I noted that the forecast job losses due to automation in the coming years are not out of line with what has been the norm in the US for at least the last 150 years.  There has always been job disruption and turnover, and while assistance should certainly be provided to workers whose jobs will be affected, what is expected in the years going forward is similar to what we have had in the past.

It is also a good thing that workers should not be expected to rely on a $12,000 per year grant to make up for a lost job.  Median earnings of a full-time worker was an estimated $50,653 in 2018, according to the Census Bureau.  A grant of $12,000 would not go far in making up for this.

So the issue is one of redistribution, and to be fair to Yang, I should note that he posts on his campaign website a fair amount of detail on how the program would be paid for.  I make use of that information below.  But the numbers do not really add up, and for a candidate who champions math (something I admire), this is disappointing.

B.  Yang’s Proposal of a $1,000 Monthly Grant to All Americans

First of all, the overall cost.  This is easy to calculate, although not much discussed.  The $12,000 per year grant would go to every adult American, who Yang defines as all those over the age of 18.  There were very close to 250 million Americans over the age of 18 in 2018, so at $12,000 per adult the cost would be $3.0 trillion.

This is far from a small amount.  With GDP of approximately $20 trillion in 2018 ($20.58 trillion to be more precise), such a program would come to 15% of GDP.  That is huge.  Total taxes and revenues received by the federal government (including all income taxes, all taxes for Social Security and Medicare, and everything else) only came to $3.3 trillion in FY2018.  This is only 10% more than the $3.0 trillion that would have been required for Yang’s $12,000 per adult grants.  Or put another way, taxes and other government revenues would need almost to be doubled (raised by 91%) to cover the cost of the program.  As another comparison, the cost of the tax cuts that Trump and the Republican leadership rushed through Congress in December 2017 was forecast to be an estimated $150 billion per year.  That was a big revenue loss.  But the Yang proposal would cost 20 times as much.

With such amounts to be raised, Yang proposes on his campaign website a number of taxes and other measures to fund the program.  One is a value-added tax (VAT), and from his very brief statements during the debates but also in interviews with the media, one gets the impression that all of the program would be funded by a value-added tax.  But that is not the case.  He in fact says on his campaign website that the VAT, at the rate and coverage he would set, would raise only about $800 billion.  This would come only to a bit over a quarter (27%) of the $3.0 trillion needed.  There is a need for much more besides, and to his credit, he presents plans for most (although not all) of this.

So what does he propose specifically?:

a) A New Value-Added Tax:

First, and as much noted, he is proposing that the US institute a VAT at a rate of 10%.  He estimates it would raise approximately $800 billion a year, and for the parameters for the tax that he sets, that is a reasonable estimate.  A VAT is common in most of the rest of the world as it is a tax that is relatively easy to collect, with internal checks that make underreporting difficult.  It is in essence a tax on consumption, similar to a sales tax but levied only on the added value at each stage in the production chain.  Yang notes that a 10% rate would be approximately half of the rates found in Europe (which is more or less correct – the rates in Europe in fact vary by country and are between 17 and 27% in the EU countries, but the rates for most of the larger economies are in the 19 to 22% range).

A VAT is a tax on what households consume, and for that reason a regressive tax.  The poor and middle classes who have to spend all or most of their current incomes to meet their family needs will pay a higher share of their incomes under such a tax than higher-income households will.  For this reason, VAT systems as implemented will often exempt (or tax at a reduced rate) certain basic goods such as foodstuffs and other necessities, as such goods account for a particularly high share of the expenditures of the poor and middle classes.  Yang is proposing this as well.  But even with such exemptions (or lower VAT rates), a VAT tax is still normally regressive, just less so.

Furthermore, households will in the end be paying the tax, as prices will rise to reflect the new tax.  Yang asserts that some of the cost of the VAT will be shifted to businesses, who would not be able, he says, to pass along the full cost of the tax.  But this is not correct.  In the case where the VAT applies equally to all goods, the full 10% will be passed along as all goods are affected equally by the now higher cost, and relative prices will not change.  To the extent that certain goods (such as foodstuffs and other necessities) are exempted, there could be some shift in demand to such goods, but the degree will depend on the extent to which they are substitutable for the goods which are taxed.  If they really are necessities, such substitution is likely to be limited.

A VAT as Yang proposes thus would raise a substantial amount of revenues, and the $800 billion figure is a reasonable estimate.  This total would be on the order of half of all that is now raised by individual income taxes in the US (which was $1,684 billion in FY2018).  But one cannot avoid that such a tax is paid by households, who will face higher prices on what they purchase, and the tax will almost certainly be regressive, impacting the poor and middle classes the most (with the extent dependent on how many and which goods are designated as subject to a reduced VAT rate, or no VAT at all).  But whether regressive or not, everyone will be affected and hence no one will actually see a net increase of $12,000 in purchasing power from the proposed grant  Rather, it will be something less.

b)  A Requirement to Choose Either the $12,000 Grants, or Participation in Existing Government Social Programs

Second, Yang’s proposal would require that households who currently benefit from government social programs, such as for welfare or food stamps, would be required to give up those benefits if they choose to receive the $12,000 per adult per year.  He says this will lead to reduced government spending on such social programs of $500 to $600 billion a year.

There are two big problems with this.  The first is that those programs are not that large.  While it is not fully clear how expansive Yang’s list is of the programs which would then be denied to recipients of the $12,000 grants, even if one included all those included in what the Congressional Budget Office defines as “Income Security” (“unemployment compensation, Supplemental Security Income, the refundable portion of the earned income and child tax credits, the Supplemental Nutrition Assistance Program [food stamps], family support, child nutrition, and foster care”), the total spent in FY2018 was only $285 billion.  You cannot save $500 to $600 billion if you are only spending $285 billion.

Second, such a policy would be regressive in the extreme.  Poor and near-poor households, and only such households, would be forced to choose whether to continue to receive benefits under such existing programs, or receive the $12,000 per adult grant per year.  If they are now receiving $12,000 or more in such programs per adult household member, they would receive no benefit at all from what is being called a “universal” basic income grant.  To the extent they are now receiving less than $12,000 from such programs (per adult), they may gain some benefit, but less than $12,000 worth.  For example, if they are now receiving $10,000 in benefits (per adult) from current programs, their net gain would be just $2,000 (setting aside for the moment the higher prices they would also now need to pay due to the 10% VAT).  Furthermore, only the poor and near-poor who are being supported by such government programs will see such an effective reduction in their $12,000 grants.  The rich and others, who benefit from other government programs, will not see such a cut in the programs or tax subsidies that benefit them.

c)  Savings in Other Government Programs 

Third, Yang argues that with his universal basic income grant, there would be a reduction in government spending of $100 to $200 billion a year from lower expenditures on “health care, incarceration, homelessness services and the like”, as “people would be able to take better care of themselves”.  This is clearly more speculative.  There might be some such benefits, and hopefully would be, but without experience to draw on it is impossible to say how important this would be and whether any such savings would add up to such a figure.  Furthermore, much of those savings, were they to follow, would accrue not to the federal government but rather to state and local governments.  It is at the state and local level where most expenditures on incarceration and homelessness, and to a lesser degree on health care, take place.  They would not accrue to the federal budget.

d)  Increased Tax Revenues From a Larger Economy

Fourth, Yang states that with the $12,000 grants the economy would grow larger – by 12.5% he says (or $2.5 trillion in increased GDP).  He cites a 2017 study produced by scholars at the Roosevelt Institute, a left-leaning non-profit think tank based in New York, which examined the impact on the overall economy, under several scenarios, of precisely such a $12,000 annual grant per adult.

There are, however, several problems:

i)  First, under the specific scenario that is closest to the Yang proposal (where the grants would be funded through a combination of taxes and other actions), the impact on the overall economy forecast in the Roosevelt Institute study would be either zero (when net distribution effects are neutral), or small (up to 2.6%, if funded through a highly progressive set of taxes).

ii)  The reason for this result is that the model used by the Roosevelt Institute researchers assumes that the economy is far from full employment, and that economic output is then entirely driven by aggregate demand.  Thus with a new program such as the $12,000 grants, which is fully paid for by taxes or other measures, there is no impact on aggregate demand (and hence no impact on economic output) when net distributional effects are assumed to be neutral.  If funded in a way that is not distributionally neutral, such as through the use of highly progressive taxes, then there can be some effect, but it would be small.

In the Roosevelt Institute model, there is only a substantial expansion of the economy (of about 12.5%) in a scenario where the new $12,000 grants are not funded at all, but rather purely and entirely added to the fiscal deficit and then borrowed.  And with the current fiscal deficit now about 5% of GDP under Trump (unprecedented even at 5% in a time of full employment, other than during World War II), and the $12,000 grants coming to $3.0 trillion or 15% of GDP, this would bring the overall deficit to 20% of GDP!

Few economists would accept that such a scenario is anywhere close to plausible.  First of all, the current unemployment rate of 3.5% is at a 50 year low.  The economy is at full employment.  The Roosevelt Institute researchers are asserting that this is fictitious, and that the economy could expand by a substantial amount (12.5% in their scenario) if the government simply spent more and did not raise taxes to cover any share of the cost.  They also assume that a fiscal deficit of 20% of GDP would not have any consequences, such as on interest rates.  Note also an implication of their approach is that the government spending could be on anything, including, for example, the military.  They are using a purely demand-led model.

iii)  Finally, even if one assumes the economy will grow to be 12.5% larger as a result of the grants, even the Roosevelt Institute researchers do not assume it will be instantaneous.  Rather, in their model the economy becomes 12.5% larger only after eight years.  Yang is implicitly assuming it will be immediate.

There are therefore several problems in the interpretation and use of the Roosevelt Institute study.  Their scenario for 12.5% growth is not the one that follows from Yang’s proposals (which is funded, at least to a degree), nor would GDP jump immediately by such an amount.  And the Roosevelt Insitute model of the economy is one that few economists would accept as applicable in the current state of the economy, with its 3.5% unemployment.

But there is also a further problem.  Even assuming GDP rises instantly by 12.5%, leading to an increase in GDP of $2.5 trillion (from a current $20 trillion), Yang then asserts that this higher GDP will generate between $800 and $900 billion in increased federal tax revenue.  That would imply federal taxes of 32 to 36% on the extra output.  But that is implausible.  Total federal tax (and all other) revenues are only 17.5% of GDP.  While in a progressive tax system the marginal tax revenues received on an increase in income will be higher than at the average tax rate, the US system is no longer very progressive.  And the rates are far from what they would need to be twice as high at the margin (32 to 36%) as they are at the average (17.5%).  A more plausible estimate of the increased federal tax revenues from an economy that somehow became 12.5% larger would not be the $800 to $900 billion Yang calculates, but rather about half that.

Might such a universal basic income grant affect the size of the economy through other, more orthodox, channels?  That is certainly possible, although whether it would lead to a higher or to a lower GDP is not clear.  Yang argues that it would lead recipients to manage their health better, to stay in school longer, to less criminality, and to other such social benefits.  Evidence on this is highly limited, but it is in principle conceivable in a program that does properly redistribute income towards those with lower incomes (where, as discussed above, Yang’s specific program has problems).  Over fairly long periods of time (generations really) this could lead to a larger and stronger economy.

But one will also likely see effects working in the other direction.  There might be an increase in spouses (wives usually) who choose to stay home longer to raise their children, or an increase in those who decide to retire earlier than they would have before, or an increase in the average time between jobs by those who lose or quit from one job before they take another, and other such impacts.  Such impacts are not negative in themselves, if they reflect choices voluntarily made and now possible due to a $12,000 annual grant.  But they all would have the effect of reducing GDP, and hence the tax revenues that follow from some level of GDP.

There might therefore be both positive and negative impacts on GDP.  However, the impact of each is likely to be small, will mostly only develop over time, and will to some extent cancel each other out.  What is likely is that there will be little measurable change in GDP in whichever direction.

e)  Other Taxes

Fifth, Yang would institute other taxes to raise further amounts.  He does not specify precisely how much would be raised or what these would be, but provides a possible list and says they would focus on top earners and on pollution.  The list includes a financial transactions tax, ending the favorable tax treatment now given to capital gains and carried interest, removing the ceiling on wages subject to the Social Security tax, and a tax on carbon emissions (with a portion of such a tax allocated to the $12,000 grants).

What would be raised by such new or increased taxes would depend on precisely what the rates would be and what they would cover.  But the total that would be required, under the assumption that the amounts that would be raised (or saved, when existing government programs are cut) from all the measures listed above are as Yang assumes, would then be between $500 and $800 billion (as the revenues or savings from the programs listed above sum to $2.2 to $2.5 trillion).  That is, one might need from these “other taxes” as much as would be raised by the proposed new VAT.

But as noted in the discussion above, the amounts that would be raised by those measures are often likely to be well short of what Yang says will be the case.  One cannot save $500 to $600 billion in government programs for the poor and near-poor if government is spending only $285 billion on such programs, for example.  A more plausible figure for what might be raised by those proposals would be on the order of $1 trillion, mostly from the VAT, and not the $2.2 to $2.5 trillion Yang says will be the case.

C.  An Assessment

Yang provides a fair amount of detail on how he would implement a universal basic income grant of $12,000 per adult per year, and for a political campaign it is an admirable amount of detail.  But there are still, as discussed above, numerous gaps that prevent anything like a complete assessment of the program.  But a number of points are evident.

To start, the figures provided are not always plausible.  The math just does not add up, and for someone who extolls the need for good math (and rightly so), this is disappointing.  One cannot save $500 to $600 billion in programs for the poor and near-poor when only $285 billion is being spent now.  One cannot assume that the economy will jump immediately by 12.5% (which even the Roosevelt Institute model forecasts would only happen in eight years, and under a scenario that is the opposite of that of the Yang program, and in a model that few economists would take as credible in any case).  Even if the economy did jump by so much immediately, one would not see an increase of $800 to $900 billion in federal tax revenues from this but rather more like half that.  And other such issues.

But while the proposal is still not fully spelled out (in particular on which other taxes would be imposed to fill out the program), we can draw a few conclusions.  One is that the one group in society who will clearly not gain from the $12,000 grants is the poor and near-poor, who currently make use of food stamp and other such programs and decide to stay with those programs.  They would then not be eligible for the $12,000 grants.  And keep in mind that $12,000 per adult grants are not much, if you have nothing else.  One would still be below the federal poverty line if single (where the poverty line in 2019 is $12,490) or in a household with two adults and two or more children (where the poverty line, with two children, is $25,750).  On top of this, such households (like all households) will pay higher prices for at least some of what they purchase due to the new VAT.  So such households will clearly lose.

Furthermore, those poor or near-poor households who do decide to switch, thus giving up their eligibility for food stamps and other such programs, will see a net gain that is substantially less than $12,000 per adult.  The extent will depend on how much they receive now from those social programs.  Those who receive the most (up to $12,000 per adult), who are presumably also most likely to be the poorest among them, will lose the most.  This is not a structure that makes sense for a program that is purportedly designed to be of most benefit to the poorest.

For middle and higher-income households the net gain (or loss) from the program will depend on the full set of taxes that would be needed to fund the program.  One cannot say who will gain and who will lose until the structure of that full set of taxes is made clear.  This is of course not surprising, as one needs to keep in mind that this is a program of redistribution:  Funds will be raised (by taxes) that disproportionately affect certain groups, to be distributed then in the $12,000 grants.  Some will gain and some will lose, but overall the balance has to be zero.

One can also conclude that such a program, providing for a universal basic income with grants of $12,000 per adult, will necessarily be hugely expensive.  It would cost $3 trillion a year, which is 15% of GDP.  Funding it would require raising all federal tax and other revenue by 91% (excluding any offset by cuts in government social programs, which are however unlikely to amount to anything close to what Yang assumes).  Raising funds of such magnitude is completely unrealistic.  And yet despite such costs, the grants provided of $12,000 per adult would be poverty level incomes for those who do not have a job or other source of support.

One could address this by scaling back the grant, from $12,000 to something substantially less, but then it becomes less meaningful to an individual.  The fundamental problem is the design as a universal grant, to all adults.  While this might be thought to be politically attractive, any such program then ends up being hugely expensive.

The alternative is to design a program that is specifically targeted to those who need such support.  Rather than attempting to hide the distributional consequences in a program that claims to be universal (but where certain groups will gain and certain groups will lose, once one takes fully into account how it will be funded), make explicit the redistribution that is being sought.  With this clear, one can then design a focussed program that addresses that redistribution aim.

Finally, one should recognize that there are other policies as well that might achieve those aims that may not require explicit government-intermediated redistribution.  For example, Senator Cory Booker in the October 15 debate noted that a $15 per hour minimum wage would provide more to those now at the minimum wage than a $12,000 annual grant.  This remark was not much noted, but what Senator Booker said was true.  The federal minimum wage is currently $7.25 per hour.  This is low – indeed, it is less (in real terms) than what it was when Harry Truman was president.  If the minimum wage were raised to $15 per hour, a worker now at the $7.25 rate would see an increase in income of $15.00 – $7.25 = $7.75 per hour, and over a year of 40 hour weeks would see an increase in income of $7.75 x 40 x 52 = $16,120.00.  This is well more than a $12,000 annual grant would provide.

Republican politicians have argued that raising the minimum wage by such a magnitude will lead to widespread unemployment.  But there is no evidence that changes in the minimum wage that we have periodically had in the past (whether federal or state level minimum wages) have had such an adverse effect.  There is of course certainly some limit to how much it can be raised, but one should recognize that the minimum wage would now be over $24 per hour if it had been allowed to grow at the same pace as labor productivity since the late 1960s.

Income inequality is a real problem in the US, and needs to be addressed.  But there are problems with Yang’s specific version of a universal basic income.  While one may be able to fix at least some of those problems and come up with something more reasonable, it would still be massively disruptive given the amounts to be raised.  And politically impossible.  A focus on more targeted programs, as well as on issues such as the minimum wage, are likely to prove far more productive.

What a Real Tax Reform Could Look Like – III: A Carbon Tax to Address Climate Change

Source:  James Hansen, Global Temperatures, update of December 18, 2017

 

A.  Introduction

The final element of a comprehensive tax reform would be a tax to address climate change.  Previous posts have looked at what a true reform of corporate and individual income taxes could look like, plus what could be done to ensure Social Security benefits can continue to be paid in accord with current formulae, and indeed enhanced.  This post will look at a tax on greenhouse gas emissions (commonly called a carbon tax, as carbon dioxide is the primary contributor) to address global warming.

There is no doubt the planet is warming –  the chart above shows the most recent estimates.  And this is primarily due to our economies pouring into the air carbon dioxide and certain other gases (such as methane) that lead to heat being retained by the atmosphere.  These greenhouse gases have warmed the planet, leading to an increased frequency of extreme weather events such as the series of remarkably intense hurricanes that hit the US this August and September.  The cost, already being incurred, has been staggering.  Early estimates of the cost of just Hurricanes Harvey (which hit Texas) and Irma (which hit Florida) reach $290 billion.  Hurricane Maria (which hit Puerto Rico) may have cost Puerto Rico as much as $95 billion according to an early estimate (and this excludes the cost to other Caribbean nations it hit).

As I am writing this (January 3, 2018), record-breaking cold has swept over much of the eastern half of the US.  And it is forecast to get worse over the next few days.  Trump has, not surprisingly, tweeted that this cold shows that global warming is not true.  But this illustrates well his ignorance.  First, there is more to the world than the eastern US.  There is also today unseasonably warm weather in the western US (especially Alaska, relative to what is normal there), as well as in Europe, Russia, and especially Siberia.  Overall, the average global surface temperature today is 0.5 degrees Celsius above the 1979 to 2000 average for this time of year, and 0.9 degrees Celsius above that average in the Northern Hemisphere.  But second, that blast of cold hitting the eastern US should not be taken as a surprising outcome of global warming.  Warming leads to greater volatility in atmospheric currents, including in the jet streams that allow (or block) cold air to come down from the Arctic.

One cannot, of course, attribute with certainty any particular severe weather event (whether hurricanes, extreme hot or cold temperatures, drought or floods, and more) to climate change.  We had severe weather events before global warming became significant.  But the same is true of lung cancer and smoking:  One cannot attribute any individual’s death from lung cancer to his or her smoking.  People died of lung cancer before smoking became common.  The issue, rather, is that smoking increases the likelihood of getting lung cancer.  Similarly, global warming increases the likelihood and hence frequency of severe weather events.

And that is precisely what we have seen.  Severe weather events have increased in number in recent years as the planet has warmed and as climate change models have predicted.  A database maintained by the National Oceanic and Atmospheric Administration (NOAA, the home of the National Weather Service) has kept track since 1980 of the number of weather and climate disasters in the US which each cost $1 billion or more (in 2017 prices).  Over that close to 37 year period the 7 worst years (in terms of the number of such disasters) have all come in the last 10 years (including 2017, which as of end September already had tied the worst full year so far, and will exceed it once fourth quarter data is included).

Global warming, arising from man-made emissions of carbon dioxide (CO2), methane (natural gas), and certain other gases (together, greenhouse gases or GHGs, for the greenhouse effect they cause), is thus imposing a huge cost already on society, and one which will get worse as the planet warms further.  It is thus a mark of confusion to say, as Trump and many Republican politicians have, that we cannot “afford” to address the causes of the warming planet.  We are already bearing the costs, and those costs will get far worse if nothing is done.  The question is whether steps will be taken to reduce those costs by addressing the underlying causes.

The issue is that the costs such GHG emissions cause are not being borne by those who emit those gases.  The emitters of GHGs are in effect being subsidized, and encouraged to burn fossil fuels rather than make use of a cleaner alternative.  And when a producer is not bearing the full cost of what he is producing, it will be badly done.  The key is to charge a tax or fee on such production equal to the cost being imposed on others, so that the producer faces the full cost of what he is making.  The producer will then have a reason to make suitable choices on how the product can be made at the least cost to all.  And consumers, facing the full costs of what they are buying, can then make suitable choices on whether to buy one product or another.

A suitable tax on greenhouse gas emissions would bring prices in line with the total costs being incurred.  A comprehensive tax reform should include this.  And it would be straightforward to implement.  There is indeed a well worked out plan being promoted by a group of traditional Republican conservatives, the Climate Leadership Council, with the active involvement and endorsements of several Treasury Secretaries in past Republican administrations (Hank Paulson, James Baker, and George Schultz); as well as of individuals such as Michael Bloomberg and liberal and conservative economists such as Larry Summers, Martin Feldstein, and Gregory Mankiw; companies such as ExxonMobil, General Motors, and Shell; and environmental organizations such as The Nature Conservancy and Conservation International.

It is a good plan, and I would suggest basically just copying it.  The proposal will be explained below.  A one-page summary of the Climate Leadership Council’s specific proposal is available here, while a more complete description is available here.  A very similar proposal has also been assessed by the US Treasury, with a brief summary of the Treasury analysis available on the Climate Leadership Council website here, while the complete Treasury analysis is available here on the Treasury website (assuming the Trump administration has not taken it down).  The Treasury assessment is excellent, as it reviews precisely how one could implement such a tax, including the practicalities, and arrives at specific quantitative estimates of the impact on different income groups.  The analysis below will basically follow the variant of the plan as assessed by the Treasury.

This post will first provide a description of that plan, how it could be implemented, and what the impact on prices might be.  Importantly, clean alternatives exist for many of the processes which emit GHGs, particularly from the burning of fossil fuels, which thus can be substituted for processes emitting those gases.  This would limit the price impact and smooth the way to sharp reductions in GHG emissions.  Furthermore, a key feature of this plan is that the revenues that would be collected by the carbon tax would all be rebated to the American population.  The final section will discuss this and the distributional implications.  The plan would be revenue neutral – the aim is to change prices so that they fully reflect the costs being incurred, not to raise revenues.  And the rebates would be distributionally positive, with the bottom seven deciles of the population (the bottom 70%) coming out ahead after the rebates.  Only the top three deciles (top 30%) would see a net loss, as a direct consequence of their disproportionate share in consumption of goods that cause the GHG emissions in the first place.

B.  A Carbon Tax to Address Climate Change

In brief, under this proposal a tax would be charged for each unit of GHG pollution emitted.  The Climate Leadership Council would set the tax to start at $40 per ton of CO2, with the taxes on other GHGs set in proportion based on their global warming impact per ton relative to that of CO2.  This is often called simply a carbon tax, although it is in fact a tax on CO2 (carbon dioxide) emissions and on other GHGs in proportion to their global warming impact.  The tax would then rise in real terms over time.  The start date would presumably have been 2018, although this was not explicit (the proposal came out in early 2017).  The Treasury variant examined a price of $49 per ton of CO2-equivalent starting in 2019 (with some phasing in of the goods to which it would apply until 2021), and then increasing at a rate of 2% a year in real terms from 2019.

Importantly, all revenues collected would be returned directly to the American population.  The impact on the federal budget thus would be revenue neutral.  There would also be border adjustments for imports and exports (discussed below).  The Treasury estimates that at $49 per ton, the carbon tax would lead to a rebate in the first year (2019) of $583 per person, or $2,332 for a family of four.  Scaling this in proportion, a $40 per ton carbon tax would lead to a rebate of $476 per person, or $1,904 for a family of four.  And the tax would be highly progressive.  The Treasury estimated that there would on average be net income gains for the bottom 70% of the population.  That is, their rebates would be greater than the higher amounts they would need to spend on goods and services to reflect the cost of the carbon tax.

In more detail, under this plan a price (whether $40 or $49 to start) would be charged which reflects the cost to society of the GHGs being emitted as part of the production process for the good or service being produced.  This is called the “social cost of carbon”, and while the concept is clear, it is difficult in practice to estimate precisely.  Its value will depend on factors which are difficult to know at this point in time, including the full cost to our economies (starting now and extending many decades into the future) as a consequence of climate change, the cost of technologies to limit GHG emissions (again starting now, and then for decades into the future), and the appropriate values for parameters such as the proper discount rate to use to put the costs and benefits over this range of time all into the prices of today.  A fundamental difficulty of GHG emissions is that their impact is not just in the near term, but can extend for centuries.  They remain in the atmosphere for a very long time.

Thus while starting at a reasonable cost of carbon (whether $40 or $49) is important, probably more important is how this price should be adjusted over time to reflect actual experience.  Some predictability in the path is also valuable, so firms can make their investment decisions accordingly.  Thus the Climate Leadership Council plan would have the price rise in real terms over time at some unspecified pace, while the Treasury assessment assumed concretely a rise of 2% a year in real terms.  Such a 2% real increase is reasonable.

One should, however, also recognize the inherent uncertainty, as the proper price on carbon is difficult to know before we have any experience with such a plan.  Thus one should allow for reassessment and adjustment, perhaps every five years or so, with the pace of price adjustment increased or decreased depending on the observed response.  The pace would be raised if we find that GHG emissions are not falling at the pace needed, or reduced if we find GHGs are falling at a more rapid pace than anticipated and needed.  Past experience with market mechanisms to reduce pollution (in particular the use of trading schemes to reduce sulfur dioxide and nitrogen oxides pollution) worked surprisingly well, with costs well below what had been anticipated and what would have been incurred through traditional regulatory regimes.  The same would be likely, in my view, if we would start to price GHG emissions.

Pricing GHG emissions is also relatively straightforward administratively for the bulk of GHG sources.  Fully 76% of GHG emissions in the US come from the burning of fossil fuels.  This rises to 83% if one adds in the emission of GHGs in the production of the fossil fuels themselves (at the mine or well-head) plus from the non-energy use of fossil fuels.  The carbon tax thus could be applied at the level of the limited number of power plants that still burn coal; at the level of petroleum refineries where substantially all crude oil must be processed; and at the level of gas pipelines as substantially all natural gas is transported via pipelines.  A limited number of industrial plants then account for a significant share of the remainder.  These include from the use of coking coals in the production of iron and steel; from the production of petrochemicals such as plastics; and GHGs resulting from the production of cement, glass, limestone, and similar products.  For these, it would be straightforward to apply a carbon tax at the factory or plant level.  There would remain GHG emissions from a range of resources, including in particular in agriculture (accounting for about 8% of GHG emissions in the US), and the Treasury analysis assumes the carbon tax would not apply to those sources.  But they are a small share of the total, and an issue one could address in the future.

A key part of the plan is that there would also be a border tax adjustment, where exports would receive a rebate for the carbon taxes paid on their production, while imports would be charged a carbon tax based on the GHGs emitted in their production.  The rebate for exports means that US production would not be disadvantaged by being located here, and there would be no incentive from this source to move such plants abroad.  This addresses the Trump criticism (and confusion) that such carbon taxes will make US industry uncompetitive.  And imports would be charged a carbon tax based on their GHG emissions to the extent such imports do not already reflect such charges (which would likely be the case, as they too would likely be given rebates in their home countries on carbon taxes paid, just as US exports would be).

A feature of this border tax adjustment is that revenues for the US would be generated (and rebated to the US population) in the case where other countries are not themselves charging a carbon tax (or the equivalent, such as in a cap and trade system), but also (given the US trade structure) even when they are.  In the first case, where other countries are not at first themselves charging such a tax, imposing the carbon tax on such imports will generate revenues which would be distributed to the US population.  This would provide a strong incentive for those other countries to join the US and start to charge a similar carbon tax.  And such a border adjustment for the carbon tax would be compliant with WTO rules on trade, as the tax would simply be ensuring that imported goods are being taxed the same as their domestic equivalents are (just as is true for a value-added tax).  This is not discrimination against imports, but rather equal treatment.

In the second case, where trading partners are themselves all charging a similar carbon tax (let’s assume), the US would still come out ahead in carbon tax revenues due to our trade structure.  US imports of goods are about 50% higher than its exports of goods, and it is primarily in the production of goods that GHGs are emitted.  Partially offsetting this in the overall trade balance, US exports of services are about 50% higher than its imports of services.  But services are a smaller share of trade, plus services are not as intensive as goods in the GHGs emitted.  Overall, the US has a current account deficit (more imports of goods and services than exports), matched by capital inflows being invested in the US.  With such a trade structure, the carbon taxes charged on imports will substantially exceed whatever is rebated on exports.  The US population would come out ahead.  Put another way, producers of goods being sold in the US are currently being provided a subsidy by not charging them for the cost we are incurring due to the greenhouse gases being emitted in their production.  Given the US trade structure, a substantial share of this subsidy is going to foreign producers.  A tax on such GHG emissions is simply the removal of this subsidy.

C.  Price Impacts, and the Viability of Clean Alternatives

Applying the carbon tax will lead producers to raise their prices if they do not otherwise adjust their processes.  For transportation fuels, for example, the Treasury analysis estimated that at $49 per ton of CO2 (and its equivalent for other GHGs), the tax would equal 44 cents per gallon for gasoline, or 50 cents per gallon for diesel fuel.  While significant, such increases are not huge.  There have been far greater fluctuations in such fuel prices in recent years in response to the price of crude oil rising or falling, and consumers and the economy have been able to accommodate such changes.

More broadly, and expressed in terms of percentage increases, the Treasury analysts estimated that if the cost increases from the carbon tax were all fully passed along, the price of gasoline would rise by 11.8%, home heating oil by 12.4%, and air transportation by 7.5%.  The price of natural gas would go up by 27.0% and the price of electricity by 16.9%, but note these are the prices of just the energy alone.  The delivered price to our homes also includes distribution and other charges.  For natural gas, for example, the energy component of my bill (in Washington, DC) was just 44% of my total bill over the last 12 months, so a 27% increase in the wholesale cost of natural gas would mean a 15% increase in my overall bill for gas.  There would be no reason for distribution and other such charges to go up by any significant amount, as their costs depend on the volume delivered and not on the wholesale cost of the gas being delivered (and similarly for electricity).  Overall, the Treasury analysis forecasts that prices in general would go up by 2.6% if the new carbon tax (at $49 per ton of CO2) were fully passed forward.

But the higher costs would provide incentives both to producers to change how they make things, and to consumers to take into account the total costs in their decisions on what to buy.  One would see this most importantly (given its share as a source of GHG emissions) in how electricity is produced.  Generating electricity by the burning of fossil fuels is now heavily subsidized, in effect, as nothing is charged for the cost of the damage done (hurricanes and other severe weather events, and more) by the resulting GHG emissions.  But even with such subsidies going to those who burn fossil fuels, solar and wind produced power is now competitive (even without the subsidies going to solar and wind – see below) for newly built power plants, and indeed has been for some years.  See the careful analysis of the relative costs that is undertaken annually by Lazard (see here for their November 2017 report).  Indeed, Lazard found in its 2017 analysis that at current costs, utility-scale solar and wind generation is now often cheaper than just the operating costs of coal or nuclear plants, thus encouraging such substitution even when the capital costs of coal and nuclear plants are treated as a sunk cost.

Furthermore, solar and wind technology is still developing, with costs falling rapidly, while at this point the further reduction in costs in traditional power generation is slow.  Lazard estimates the levelized cost of energy production at a new installation (in terms of dollars of overall costs, including capital costs, per megawatt hour of electricity generated, and excluding explicit subsidies on renewables) fell by 72% between 2009 and 2017 for utility-scale solar installations and by 47% for wind generation (to prices of $50 and $45 per megawatt hour, for solar and wind respectively; this is equivalent to 5 cents and 4.5 cents per kilowatt hour).  In contrast, the cost for power generated by coal fell by just 8% over this period (to $102 per megawatt hour) and by 28% for natural gas (to $60).  And the full levelized cost for nuclear power generation actually rose by 20% over the period (to $148).

There is, of course, wide variability in the cost of solar and wind across the country, depending on local conditions.  Existing coal and nuclear plants are also of various ages and efficiencies, and hence also of varying costs.  Thus overall averages tell only part of the story.  The cost competitiveness (on average) of new installations does not mean that all new installations will be solar or wind, much less that all generation would or could shift immediately.  But the now competitive costs have led to a bit over 50% of all new generation capacity built in the US over the last 10 years (2007 to 2016) to come from installations of solar, wind, or other renewables (with most of the solar coming only in the second half of that period).

No transition will be instantaneous, but should a significant carbon tax be imposed (of $40 or $49, for example), one should see an acceleration in the pace of such substitution of renewables for fossil fuels.  And with such substitution, the impact on higher power prices will be limited in time, and should soon decline.

The other major user of fossil fuels is transportation, and here one sees a similar dynamic.  Electric battery powered cars are now either competitive in cost or close to it (depending on how one values other attributes, such as better performance and inherently easier maintenance), and a carbon tax will accelerate the transition to such vehicles.  And battery-powered vehicles are not just limited to cars.  Tesla has announced plans to produce heavy trucks powered by batteries, with a range of up to 500 miles on a charge.  Costs would be more than competitive with traditional fueled heavy trucks, and a substantial number of pre-orders have indeed already come in from owners of large trucking fleets.  There is an interest at least in trying this.  And with battery-powered heavy trucks possible, the same is true for full-size buses.

Again, starting to charge for the costs borne by society from the CO2 and other GHGs emitted in transportation would accelerate the shift to less polluting vehicles.  It won’t happen overnight.  But that shift will limit the extent and duration of higher costs stemming from charging a carbon tax.

And while such a tax alone will not lead to zero GHG emissions with current technologies available, it would be a giant step in that direction.  It would also provide a strong incentive to develop the technologies that would carry this further and at a lower cost.

D.  Distributional Implications

Finally and importantly, the funds collected by the carbon tax would be fully rebated to all Americans, with the same amount rebated per person.  The Treasury analysis estimated that at $49 per ton of CO2 in 2019, the carbon tax would collect funds sufficient to provide a rebate of $583 per person (for the year), or $2,332 for a family of four.  The rebate could be provided annually or quarterly, or even monthly, and through the IRS or Social Security.

The rebates would also be distributionally positive.  The poor would indeed benefit on a net basis.  Being poor, they do not consume that much, and thus do not account for a high share of GHG emissions.  The rich, in contrast, not only consume more (they are rich, and can afford more), but the products they buy are also more polluting in greenhouse gases (big gas-guzzling cars rather than small fuel-efficient ones; jet travel for vacations but not public transit; large homes kept heated and air-conditioned rather than smaller homes and apartments; etc.).  Thus the rich will receive back less than what is paid in carbon taxes on the goods they consume, while the poor will receive back more.  Furthermore, because the poor are poor, a given dollar amount rebated to them will be a higher percentage of their (low) incomes, than the same dollar amount would be (in percentage terms) for the rich.

The impacts are significant.  The Treasury analysis (based on data they use for their tax simulation models) concluded that the impacts by family income decile would be:

Net Impact on Income from $49 per ton Carbon Tax, with $583 per Person Rebate, by Family Decile

Decile

% of Income

0 to 10

+8.9%

10 to 20

+4.7%

20 to 30

+3.1%

30 to 40

+2.0%

40 to 50

+1.2%

50 to 60

+0.6%

60 to 70

+0.1%

70 to 80

-0.3%

80 to 90

-0.7%

90 to 100

-1.0%

Families are ranked here by income decile, so the first decile (0 to 10%) is made up of the 10% of families (in number) who have the lowest incomes, the second decile (10 to 20%) is made up of the 10% of families with the next lowest incomes, and so on, up to the richest 10% of families (90 to 100%).

The results indicate that on a net basis (i.e. after taking account of the higher prices that would be paid on goods purchased, reflecting the carbon tax at $49 per ton), the lowest income decile families would see an increase in their real incomes of 8.9% following the $583 per person rebate.  This is quite substantial.  And the analysis found there would be a similar, positive, gain for all families up through the 7th decile, although at diminishing shares of their income.  The top 3 deciles would end up paying more on a net basis, due to their greater purchases of goods where greenhouse gases are emitted (both in total amount and in the mix of their goods).  But the net cost reaches just 1% of incomes for the richest decile.  It is only a small share in part because their incomes are of course the highest.  This tax is not unaffordable.

E.  Conclusion

To conclude, imposing a carbon tax is administratively practical, would bring prices and costs in line with the costs being borne by society when greenhouse gases are emitted, and even with current technologies would lead to a significant shift away from processes that are warming our planet.  It is a fundamental confusion to assert, as Trump and others have done, that “we cannot afford it”.  That is nonsense:  We are paying the costs already (in an increased frequency of severe weather events, in droughts in some areas and floods in others, and other such impacts), and they will get far worse if nothing is done.  Furthermore, such a carbon tax would not reduce our competitiveness when applied equally to imported items (and rebated for exports).  Indeed, with our current trade structure, the US would come out ahead financially by starting to charge for GHG emissions.

Such a tax also would be distributionally highly progressive, as the poor would come well ahead on a net basis with the revenues collected being rebated back to the population.  Indeed, it is estimated that the bottom 70% of the population would come out ahead on a net basis.  And while the rich would end up paying more, reflecting their greater consumption and the GHG intensity of the goods they buy, this would come just to 1% of the incomes of the richest 10% of the population.

Such a tax on GHG emissions would be the final component of what a comprehensive tax reform really should have looked like.  As discussed in the preceding posts on this blog, there should have been a reform to simplify corporate and individual income taxes (with all sources of income taxed similarly), plus action taken on Social Security taxes to ensure the system will be sustained for the foreseeable future.  None of this was done.  Nor was any action taken to address climate change, where the subsidy we are implicitly providing fossil fuels and other sources of greenhouse gas emissions (by not charging for the damage being done as a result of those emissions) could have been addressed by a tax on such emissions.

This is not surprising, unfortunately.  There are important vested interests in the fossil fuel industries (coal, oil, and gas) that benefit from not being charged for the damage their fuels are causing.  As a rationalization of this, Trump and much of the Republican Party continue to deny that climate change even exists.  But the result will be that the damage being done, already large, will grow over time.  Plus, once the doubters do finally recognize it, the actions that will then need to be taken will be more costly and disruptive than if action were taken now.

As discussed above, there is no practical or special administrative difficulty to addressing the climate change problem now.  It would be straightforward to implement a tax on GHG emissions.  And the sooner this is done, the better.

What a Real Tax Reform Could Look Like – II: Social Security

A.  Introduction

The previous post on this blog looked at what a true tax reform could look like, addressing issues pertaining to corporate and individual income taxes.  This post will look at what should be done for Social Security and the taxes that support it.  Our federal tax system involves more than just income taxes.  Social Security taxes are important, and indeed many individuals pay more in Social Security taxes than they do in individual income taxes.  Overall, Social Security taxes account for just over a quarter of total federal revenues collected in FY2017, and are especially important for the poor and middle classes.  With a total tax of 12.4% for Social Security (formally half paid by the employee and half by the employer, but in reality all ultimately paid by the employee), someone in the 10% income tax bracket is in fact paying tax at a 22.4% rate on their wages, someone in a 15% bracket is actually paying 27.4%, and so on up to the ceiling on wages subject to this tax of $128,400 in 2018.  They also pay a further 2.9% tax on wages for Medicare (with no ceiling), but this post will focus just on the Social Security side.

And as is well known, the Social Security Trust Fund is forecast to be depleted by around 2034 if Congress does nothing.  Social Security benefits would then be automatically scaled back by about 22%, to a level where the then current flows going into the Trust Fund would match the (cut-back) outflows.  This would be a disaster for many.  Congress needs to act.

A comprehensive tax reform thus should include measures to ensure the Social Security Trust Fund remains solvent, and is at a minimum able, for the foreseeable future, to continue to pay its obligations in full.  Also, and as will be discussed below, Social Security benefit payments are embarrassingly small.  Cutting them further is not a “solution”.  And despite their small size, many now depend on Social Security in their old age, especially as a consequence of the end of most private company defined benefit pension schemes in recent decades.  We really need to look at what can be done to strengthen and indeed expand the Social Security safety net.  The final section below will discuss a way to do that.

B.  Remove the Ceiling on Wages Subject to Social Security Tax

As was discussed in an earlier post on this blog, the Social Security Trust Fund is forecast to run out by around 2034 not because, as many presume, baby boomers will now be retiring, nor because life expectancies are turning out to be longer.  Both of these factors were taken into account in 1983, when following recommendations made by a commission chaired by Alan Greenspan, Social Security tax rates were adjusted and other measures taken to ensure the Trust Fund would remain solvent for the foreseeable future.  Those changes were made in full awareness of when the baby boomers would be retiring – they had already been born.  And while life expectancy has been lengthening, what matters is not whether life expectancy has been growing longer or not, but rather whether it has been growing to be longer than what had earlier been forecast when the changes were made in 1983.  And it hasn’t:  Life expectancy has turned out to be growing more slowly than earlier forecast, and for some groups has actually been declining.  In itself, this would have lengthened the life of the Social Security Trust Fund over what had been forecast.  But instead it was shortened.

Why is it, then, that the Trust Fund is now forecast to run out by around 2034 and not much later?  As discussed in that earlier post, the Greenspan Commission assumed that wage income inequality would not change going forward.  At the time (1983) this was a reasonable assumption to make, as income inequality had not changed much in the post World War II decades leading up to the 1980s.  But from around 1980, income distribution worsened markedly following the Reagan presidency.  This matters.  Wages above a ceiling (adjusted annually according to changes in average nominal wages) are exempted from Social Security taxes.  But with the distribution of wages becoming increasingly skewed (in favor of the rich) since 1980, adjusting the ceiling according to changes in average wages will lead to an increasing share of wages being exempted from tax.  An increasing share of wage income has been pulled into the earnings of those at the very top of the income distribution, so an increasing share of wages has become exempt from Social Security taxes.  As a direct consequence, the Social Security Trust Fund did not receive the inflows that had been forecast.  Thus it is now forecast to run out by 2034.

Unfortunately, we cannot now go back in time to fix the rates and what they covered to reflect the consequences of the increase in inequality.  Thus what needs to be done now has to be stronger than what would have been necessary then.  Given where we are now, one needs to remove the ceiling on wages subject to the Social Security tax altogether to ensure system solvency.  If that were done, the depletion of the Social Security Trust Fund (with all else unchanged, including the benefit formulae) would be postponed to about 2090.  Given the uncertainties over such a time span (more than 70 years from now), one can say this is for the foreseeable future.

The chart at the top of this post (taken from the earlier blog post on this issue) shows the paths that the Social Security Trust Fund to GDP ratio would take.  If nothing is done, the Trust Fund would be depleted by around 2034 and then turn negative (not allowed under current law) if all benefits were continued to be paid (the falling curve in black).  But if the ceiling on wages subject to tax were removed, the Trust Fund would remain positive (the upper curves in blue, where the one in light blue incorporates the impact of the resulting benefit changes under the current formulae, as benefits are tied to contributions).

As discussed in that earlier blog post, the calculations indicate the Social Security Trust Fund then would remain solvent to a forecast year of about 2090.  That is over 70 years from now, and the depletion at that time is largely driven by the assumption (by the Social Security demographers) on how fast life expectancy is forecast to rise in the future.  This could again be over-estimated.

Lifting the ceiling on wages subject to Social Security tax would also be equitable:  The poor and middle classes are subject to the 12.4% Social Security tax on all of their wages; a rich person should be similarly liable for the tax on all of his or her earnings.  And I cannot see the basis for any argument that a rich person making a million dollars a year cannot afford the tax, while a poor person can.

C.  Apply the Social Security Tax to All Forms of Income, Not Just Wages, and Then Raise Benefits

But I would go further.  In the modern era, there is no reason why the Social Security tax should be applied solely to wage earnings, while earnings from wealth are not taxed at all.  As one of the basic principles of taxation noted in the previous post on tax reform, all forms of income should be taxed similarly, and not with differing rates applied to one form (e.g. 12.4% on wages) as compared to another (e.g. 0% on income from wealth).

Broadening the base would allow, if nothing else is changed, for a reduction in the rate to produce the same in revenues.  We can calculate roughly what that lower rate would be.  Making use of IRS data for incomes reported on the Form 1040s in 2015 (the most recent year available), one can calculate that if Adjusted Gross Income (line 37 of Form 1040) was used as the base for the Social Security tax rather than just wages, the Social Security tax rate could be cut from 12.4% to 8.6% to generate the same in revenues.  That is, taxing all reported income (including income from wealth) at an 8.6% rate (instead of taxing just wages at 12.4%) would generate sufficient revenues for the Social Security Trust Fund to remain solvent for the foreseeable future.  This would be a more than 30% fall in the taxes on wages, but also, of course, a shift to those who also earn a substantial share of their income from wealth.

[Note:  There would also be second-order effects as Social Security benefits paid are tied to the taxes paid over the highest 40 years of an individual’s earnings, there is some progressivity in the formulae used, and taxes on all earnings rather than just on wages will shift the share of the taxes paid towards the rich.  But the impact of these second-order effects would be relatively small.  Also, the direction of the impact would be that the break-even tax rate could be cut a bit further to allow for the same to be paid out in benefits, or a bit more in benefits could be paid for the same tax rate.  But given that the impact would be small, we will leave them out of the calculations here.]

The 8.6% tax on all forms of income would generate the revenues needed to keep the Social Security Trust Fund solvent at the benefit levels as defined under current law.  But Social Security benefit payments are embarrassingly small.  Using figures for September 2017 from the Social Security Administration, the average benefit paid (in annualized terms) for all beneficiaries is just $15,109, for retired workers it is $16,469, and for those on disability it is $12,456.  These are not far above (and for disability indeed a bit below) the federal poverty guideline level of $13,860 in 2017 for a single individual.  And the average benefit levels, being averages, mean approximately half of the beneficiaries are receiving less.

Yet even at such low levels, Social Security benefits account for 100% of the income of 20% of beneficiaries aged 65 or higher; for 90% or more of the incomes of 33% of those aged beneficiaries, and 50% or more of the incomes of 61% of those aged beneficiaries (data for 2014; see Table 9.A1).  And for those aged 65 or older whose income is below the federal poverty line, Social Security accounts for 100% of the income of 50% of them, for 90% or more of the income of 74% of them, and for 50% or more of the income for 93% of them (see Table 9.B8).  The poor are incredibly dependent on Social Security.

Thus we really should be looking at a reform which would allow such benefit payments to rise.  The existing levels are too low to serve as an effective safety net in a country where defined benefit pension plans have largely disappeared, and the alternative approach of IRAs and 401(k)s has failed to provide adequate pensions for many if not most workers.

Higher benefits would require higher revenues.  To illustrate what might be done, suppose that instead of cutting the Social Security tax rate from the current 12.4% to a rate of 8.6% (which would just suffice to ensure the Trust Fund would remain solvent at benefit levels as defined under current law), one would instead cut the tax rate just to 10.0%.  This would allow average Social Security benefits to rise by 15.8% (= 10.0%/8.6%, but based on calculations before rounding).  One can work out that based on the distribution of Social Security benefit payments in 2015 (see table 5.B6 of the 2016 Annual Statistical Supplement), that if benefits were raised by 5% for the top third of retirees receiving Social Security and by 10% for the middle third, then the extra revenues would allow us to raise the average benefit levels by 45% for the bottom (poorest) third:

Annual Social Security Benefits

Avg in 2015

% increase

New

Difference

   Bottom Third of Retirees

$8,761

45%

$12,733

   $3,972

   Middle Third of Retirees

$16,010

15%

$18,411

   $2,401

   Top Third of Retirees

$23,591

5%

$24,771

   $1,180

Overall for Retirees

$16,044

15.8%

$18,574

   $2,531

This would make a significant difference to those most dependent in their old age on Social Security.  The poorest third of retirees receiving Social Security received (in December 2015 and then annualized) a payment of just $8,761 per year.  Increasing this by 45% would raise it to $12,733.  While still not much, it would be an increase of almost $4,000 annually.  And for a married couple where both had worked and are now receiving Social Security, the benefits would be double this.  It would make a difference.

D.  Conclusion

Conservatives have long been opposed to the Social Security system (indeed since its origin under Roosevelt), arguing that it is a Ponzi scheme, that it is unsustainable, and that the only thing we can do is to scale back benefits.  None of this is true.  Rather, Social Security has proven to be a critically important support for the incomes of the aged.  An astonishingly high share of Americans depend on it, and its importance has only increased with the end of defined benefit pension schemes for most American workers.

But there are, indeed, problems.  Due to the ceiling on wages subject to Social Security tax, and the sharp increase in inequality starting in the 1980s under Reagan and continuing since, an increasing share of wages in the nation have become exempt from this tax.  As a consequence, and if nothing is done, the Trust Fund is now forecast to run out in 2034.  This would trigger a scaling back of the already low benefits by 22%.  This would be a disaster for many.

Lifting the ceiling on wages, so that all wages are taxed equally, would resolve the Trust Fund solvency issue for the foreseeable future (to a forecast year of about 2090).  Benefits as set under the current formulae could then be maintained.  Furthermore, if the base for the tax were extended to all forms of income (including income from wealth), and not limited just to wages, benefits as set under current formulae could be sustained with the tax rate cut from the current 12.4% to a new rate of just 8.6%.

But as noted above, current benefits are low.  One should go further.  Cutting the rate to just 10%, say, would allow for a significant increase in benefits.  Focussing the increase on the poorest, who are most dependant on Social Security in their old age, a rate of 10% applied to all forms of income would allow benefits to rise by 5% for the top third of retirees, by 15% for the middle third, and by a substantial 45% for the bottom third.  This would make a real difference.