The Revenue and Distributional Impacts of the Senate Republican Tax Plan

A.  Introduction

To truly understand the Republican tax plans now winding their way through Congress, one must look at the specifics of what is being proposed.  And the more closely one looks, the more appalling these plans are seen to be.  The blatant greed is breathtaking.  Despite repeatedly asserting that the plans would provide tax cuts for the middle class, the specific proposals now before Congress would in fact do the opposite.  Figures will be provided below.  And while the Secretary of the Treasury has repeatedly stated that only millionaires will pay more in taxes, the specific proposals now before Congress would in fact give millionaires huge cuts in the taxes they owe.

While provisions in the plans are changing daily, with certain differences between the versions being considered in the House and in the Senate as well as between these and what the White House set out in late September, the overall framework has remained the same (as the proponents themselves are emphasizing).  And this really is a Republican plan.  The House version was passed on a largely party-line vote with no Democrats in favor and only a small number of Republicans opposed, and the Senate version will require (assuming all Democrats vote against as they have been shut out of the process) 50 of the 52 Republican Senators (96%) to vote in favor.  The Republican leadership could have chosen to work with Democrats to develop a proposal that could receive at least some Democratic support, but decided not to.  Indeed, while their plans have been developed by a small group since Trump assumed the presidency in January, the specifics were kept secret as long as possible.  This made it impossible (deliberately) for there to be any independent analysis.  They are now trying to rush this through the House and the Senate, with votes taken as quickly as possible before the public (and the legislators themselves) can assess what is being voted upon.  The committees responsible for the legislation have not even held any hearings with independent experts.  And the Congressional Budget Office has said it will be unable to produce the analysis of the impacts normally required for such legislation, due to the compression of the schedule.

Fortunately, the staff of the Joint Committee on Taxation (JCT, a joint committee of both the House and the Senate) have been able to provide limited assessments of the legislation, focused on the budgetary and distributional impacts, as they are minimally required to do.  This blog post will use their most recent analysis (as I write this) of the current version of the Senate bill to look at who would be gaining and who would be losing, if this plan is approved.

As a first step, however, it would be good to address the claim that these Republican tax plans will spur such a jump in economic growth that they will pay for themselves.  This will not happen.  First, as earlier posts on this blog have discussed, there is no evidence from the historical data to support this.  Taxes, both on individuals and at the corporate level, have been cut sharply in the US since Reagan was president, and they have not led to higher growth.   All they did was add to the deficit.  Nor does one see this in the long-term data.  The highest individual income tax rates were at 91 or 92% (at just the federal level) between 1951 and 1963, and at 70% or more up until 1980.  The highest corporate income tax rate was 52% between 1952 and 1963, and then 46% or more up until 1986.  Yet the economy performed better in these decades than it has since.  The White House is also claiming that the proposed cut in corporate income taxes will lead to a rise in real wages of $4,000 to $9,000.  But there is no evidence in the historical data to support such a claim, which many economists have rejected as just absurd.  Corporate income tax rates were cut sharply in 1986, under Reagan, but real wages did not then rise – they in fact fell.

Finally, the assertion that tax cuts will lead to a large jump in growth ignores that the economy is already at full employment.  Were there to be an incipient rise in growth, leading to employment gains, the Federal Reserve Board would have to raise interest rates to keep the economy from over-heating.  The higher interest rates would deter investment, and one would instead have a shift in shares of GDP away from investment and towards consumption and/or government spending.

Any impact on growth would thus be modest at best.  The Tax Policy Center, using generous assumptions, estimated the tax plan might increase GDP by a total of 0.3% in 2027 and by 0.2% in 2037 over what it would otherwise then be.  An increase of 0.2% over 20 years means an increase in the rate of growth of an average of just 0.01% a year.  GDP figures are not even measured to that precision.

There would, however, be large distributional effects, with some groups gaining and some losing simply from the tax changes alone (and ignoring, for the purposes here, the further effects from a higher government debt plus increased pressures to cut back on government programs).  This blog post will discuss these, from calculations that draw on the JCT estimates of the revenue and distributional impacts.

B.  Revenue Impacts by Separate Tax Programs

The distributional consequences of the proposed changes in tax law depend on which separate taxes are to be cut or increased, what changes are made to arrive at what is considered “taxable income” (deductions, exemptions, etc.), and how those various taxes impact different individuals differently.  Thus one should first look at the changes proposed for the various taxes, and what impacts they will have on revenues collected.

The JCT provides such estimates, at a rather detailed level as well as year by year to FY2027.  The JCT estimates for the tax plan being considered in the Senate as of November 16 is available here.  Estimates are provided of the impacts of over 144 individual changes, for both income taxes on individuals and on various types of business (corporate and other).  A verbal description from the JCT of the Senate chair’s initial proposal is available here, and a description of the most recent changes in the proposal (as of November 14) is available here.  I would encourage everyone to look at the JCT estimates to get a sense of what is being proposed.  It is far more than what one commonly sees in the press, with many changes (individually often small in terms of revenue impact) that can only be viewed as catering to various special interests.

I then aggregated the JCT individual line estimates of the revenue impacts over FY18-27 to a limited set of broad categories to arrive at the figures shown in the chart at the top of this post, and (in a bit more detail) in the following table,:

Revenue Impact of Tax Plan ($billions)

FY18-27

A)  Individual excl. Estate, AMT, & Pass-Through:

  1)  Cuts

-$2,497

  2)  Increases 

 $2,688

     Net, excl. Estate, AMT, & Pass-Through  

    $191

B)  Primarily Applicable to the Rich:

  1)  Increase Estate Tax Exemption

     -$83

  2)  End Alternative Minimum Tax

   -$769

  3)  Tax Pass-Through Income at Lower Rates

   -$225

     Total for Provisions Primarily for Rich

-$1,077

C)  Business – Domestic Income:

  1)  Cut Tax Rate 35% to 20%, and End AMT 

-$1,370

  2)  Other Tax Cuts

   -$139

  3)  Tax Increases

    $826

     Net for Domestic Business

   -$682

D)  Business – Overseas Income:

  1)  End Taxation of Overseas Profit

  -$314

  2)  Other Tax Cuts

    -$21

  3)  Tax Increases (except below)

     $32

     Net for Overseas, excl. amnesty & anti-abuse 

  -$303

  4)  Partial Amnesty on Overseas Profit

    $185

  5)  Anti-abuse, incl. in Tax Havens

    $273

     Overall Totals

-$1,414

Source:  Calculated from estimated tax revenue effects made by the staff of the Joint Committee on Taxation, publication JCX-59-17, November 17, 2017, of the November 16 version of the Republican Chairman’s proposed tax legislation.

a)  Individual Income Taxes

As the chart and table show, while overall tax revenues would fall by an estimated $1.4 trillion over FY18-27 (excluding interest on the resulting higher public debt), not everyone would be getting a cut.  Proposed changes that would primarily benefit rich individuals (doubling the Estate Tax exemption amount to $22 million for a married couple, repealing the Alternative Minimum Tax in full, and taxing pass-through business income at lower rates than other income) would reduce the taxes the rich owe under these provisions by close to $1.1 trillion.  But individual income taxes excluding these three categories would in fact increase, by an estimated $191 billion over the ten years.

This increase of $191 billion in income taxes that most affect the middle and lower income classes, is not a consequence of an explicit proposal to raise their taxes.  That would be too embarrassing.  Rather, it is the net result of numerous individual measures, some of which would reduce tax liability (and which the politicians then emphasize) while others would increase tax liabilities (and are less discussed).  Cuts totaling $2.5 trillion would come primarily from reducing tax rates, from what they refer to as a “doubling” of the standard deduction (in fact it would be an increase of 89% over the 2017 level), and from increased child credits.  But there would also be increases totaling close to $2.7 trillion, primarily from eliminating the personal exemption, from the repeal of or limitation on a number of deductions one can itemize, and from changes that would effectively reduce enrollment in the health insurance market.

Part of the reason for this net tax increase over the full ten years is the decision to try to hide the full cost of the tax plan by making most of the individual income tax provisions (although not the key changes proposed for corporate taxes) formally temporary.  Most would expire at the end of 2025.  The Republican leadership advocating this say that they expect Congress later to make these permanent.  But if so, then the true cost of the plan would be well more than the $1.5 trillion ceiling they have set under the long-term budget plan they pushed through Congress in September.  Furthermore, it makes only a small difference if one calculates the impact over the first five years of the plan (FY18-22).  There would then be a small net reduction in these individual income taxes (excluding Estate Tax, AMT, and Pass-Through) of just $57 billion.  This is not large over a five year period – just 0.6% of individual income taxes expected to be generated over that period.  Over this same period, the cuts in the Estate Tax, the AMT, and for Pass-Through income would total $535 billion, or well over nine times as much.

One should also keep in mind that these figures are for overall amounts collected, and that the impact on individuals will vary widely.  This is especially so when the net effect (an increase of close to $200 billion in the individual income taxes generated) is equal to the relatively small difference between the tax increases ($2.7 trillion in total) and tax cuts ($2.5 trillion).  Depending on their individual circumstances, many individuals will be paying far more, and others far less.  For example, much stress has been put on the “doubling” of the standard deduction.  However, personal exemptions would also be eliminated, and in a household of just three, the loss of the personal exemptions ($4,050 per person in 2017) would more than offset the increase in the standard deduction (from $12,700 to a new level of $24,000).  The change in what is allowed for the separate child credits will also matter, but many households will not qualify for the special child credits.  And if one is in a household which itemizes their deductions, both before and after the changes and for whatever reason (such as for high medical expenses), the “doubling” of the standard deduction is not even relevant, while the elimination of the personal exemptions is.

Taxes relevant to the rich would be slashed, however.  Only estates valued at almost $22 million or more in 2017 (for a married couple after some standard legal measures have been taken, and half that for a single person) are currently subject to the Estate Tax, and these account for less than 0.2% of all estates.  The poorer 99.8% do not need to worry about this tax.  But the Senate Republican plan would narrow the estates subject to tax even further, by doubling the exemption amount.  The Alternative Minimum Tax (AMT) is also a tax that only applies to relatively well-off households.  It would be eliminated altogether.

And pass-through income going to individuals is currently taxed at the same rates as ordinary income (such as on wages), at a rate of up to 39.6%.  The current proposal (as of November 16) is to provide a special deduction for such income equal to 17.4%.  This would in effect reduce the tax rate applicable to such income from, for example, 35% if it were regular income such as wages (the bracket when earnings are between $400,000 and $1.0 million in the current version of the plan) to just 28.9%.  Pass-through income is income distributed from sole proprietorships, partnerships, and certain corporations (known as sub-chapter S corporations, by the section in the tax code).  Entities may choose to organize themselves in this way in order to avoid corporate income tax.  Those receiving such income are generally rich:  It is estimated that 70% of such pass-through income in the US goes to the top 1% of earners.  Such individuals may include, for example, the partners in many financial investment firms, lawyers and accountants, other professionals, as well as real estate entities. There are many revealing examples.  According to a letter from Trump’s own tax lawyers, Trump receives most of his income from more than 500 such entities.  And Jeff Bezos, now the richest person in the world, owns the Washington Post through such an entity (although here the question might be whether there is any income to be passed through).

The JCT estimates are that $83 billion in revenue would be lost if the Estate Tax exemption is doubled, $769 billion would be lost due to a repeal of the AMT, and $225 billion would be lost as a result of the special 17.4% deduction for pass-through income.  This sums to $1,077 billion over the ten years.

Rich individuals thus will benefit greatly from the proposed changes.  Taxes relevant just to them will be cut sharply.  These taxes are of no relevance to the vast majority of Americans.  With the proposal as it now stands, most Americans would instead end up paying more over the ten year period.  And even if all the provisions with expiration dates (mostly in 2025) were instead extended for the full period, the difference would be small, with at best a minor cut on average.  It would not come close to approaching the huge cuts the rich would enjoy.

b)  Taxes on Income of Corporations and Other Businesses

The proposed changes in taxes on business incomes are more numerous.  They would also in general be made permanent (with some exceptions), rather than expire early as would be the case for most of the individual income tax provisions.  There are also numerous special provisions, with no obvious explanation, which appear to be there purely to benefit certain special interests.

To start, the net impact on domestic business activities would be a cut of an estimated $682 billion over the ten year period.  The lower tax revenues result from cutting the tax rate on corporate profits from 35% to 20%, plus from the repeal of the corporate AMT.  The cuts would total $1,370 billion.  This would be partially offset by reducing or eliminating various deductions and other measures companies can take to reduce their taxable income (generating an estimated $826 billion over the period).

However, there would also be measures that would cut business taxes even further (by an estimated $139 billion) on top of the impact from the lower tax rates (and elimination of the AMT).  Most, although not all, of these would be a consequence of allowing full expensing, or accelerated depreciation in some cases, of investments being made (with such full expensing expiring, in most cases, in 2022).  The objective would be to promote investment further.  This is reasonable, but with full expensing of investments many question whether anything further is gained, in terms of investment expenses, from cutting the corporate rate to 20%.

Special provisions include measures for the craft beer industry, which would reduce tax revenues by $4.2 billion.  The rationale behind this is not fully clear, and it would expire in just two years, at the end of 2019.  The measures should be made permanent if they are in fact warranted, but their early expiration suggests that they are not.  Also odd is a provision to allow the film, TV, and theater industries to fully expense certain of their expenses.  But this provision would expire in 2022.  If warranted, it should be permanent.  If not, it should probably not be there at all.

There are a large number of such special provisions.  Individually, their tax impact is small.  Even together the impact is not large compared to the other measures being proposed.  They mostly look like gifts to well-connected interests.

Others lose out.  These include provisions that allow companies to include as a cost certain employee benefits, such as for transportation, for certain employee meals (probably those provided in remote locations), and for some retirement savings provisions.  Workers would likely lose from this.  The proposal would also introduce new taxes on universities and other non-profits, including taxes on certain endowment income and on salaries of certain senior university officials (beyond what they already pay individually).  The revenues raised would be tiny, and this looks more like a punitive measure aimed at universities than something justified as a “reform”.

There would also be major changes in the taxes due on corporate profits earned abroad.  Most importantly, US taxes would no longer be due on such activities.  While this would cost in taxes a not small $314 billion (or $303 billion after a number of more minor cuts and increases are accounted for) over the ten years, also significant is the incentive this would create to relocate plants and other corporate activities to some foreign location where local taxes are low.  There would be a strong incentive, for example, to relocate a plant to Mexico, say, if Mexico offered only a low tax on profits generated by that plant.  The same plant in the US would pay corporate income taxes at the (proposed) 20% rate.  How this incentive to relocate plant abroad could possibly be seen as a positive by politicians who say they favor domestic jobs is beyond me.  It appears to be purely a response to special interests.

The corporate tax cuts are then in part offset by a proposal to provide a partial amnesty on the accumulated profits now held overseas by US companies.  Certain assets held overseas as retained earnings would be taxed at 5% and certain others at 10%.  Under current US law, corporate profits earned overseas are only subject to US taxes (at the 35% rate currently, net of taxes already paid abroad in the countries where they operate) when those profits are repatriated to the US.  As long as they are held overseas, they are not taxed by the US.  An earlier partial amnesty on such profits, in 2004 during the Bush administration, led to the not unreasonable expectation that there would again be a partial amnesty on such taxes otherwise due when Republicans once again controlled congress and the presidency.  This created a strong incentive to hold accumulated retained earnings overseas for as long as possible, and that is exactly what happened.  Profits repatriated following the 2004 law were taxed at a rate of just 5.25%.

The result is that US companies now hold abroad at least $2.6 trillion in earnings.  And this $2.6 trillion estimate, commonly cited, is certainly an underestimate.  It was calculated based on a review of the corporate financial disclosures of 322 of the Fortune 500 companies, for the 322 such companies where disclosures permitted an estimate to be made.  Based also on the deductible foreign taxes that had been paid on such overseas retained earnings, the authors conservatively estimate that $767 billion in corporate income taxes would be due on the retained earnings held overseas by the 322 companies.  But clearly it would be far higher, as the 322 companies, while among the larger US companies, are only a sub-set of all US companies with earnings held abroad.

Thus to count the $185 billion (line D.4. in the table above) as a revenue-raising measure is a bit misleading.  It is true that compared to doing nothing, where one would leave in place current US tax law which allows taxes on overseas profits to be avoided until repatriated, revenues would be raised under the partial amnesty if those accumulated overseas earnings are now taxed at 5 or 10%.  But the partial amnesty also means that one will give up forever the taxes that would otherwise be due on the more than $2.6 trillion in earnings held overseas.  Relative to that scenario, the amnesty would lead to a $582 billion loss in revenues (equal to an estimated $767 billion loss minus a gain of $185 billion from the 5 and 10% special rates of the amnesty; in fact the losses would be far greater as the $767 billion figure is just for the 322 companies which publish data on what they are holding abroad).  This is, of course, a hypothetical, as it would require a change in law from what it is now.  But it does give a sense of what is being potentially lost in revenues by providing such a partial amnesty.

But even aside from this, one must also recognize that the estimated $185 billion gain in revenues over the next few years would be a one time gain.  Once the amnesty is given, one has agreed to forego the tax revenues that would otherwise be due.  It would help in reducing the cost of this tax plan over the next several years, but it would then lead to losses in taxes later.

Finally, as is common among such tax plans, there is a promise to crack down on abuses, including in this case the use of tax havens to avoid corporate taxes.  The estimate is that such actions and changes in law would raise $273 billion over the next ten years.  But based on past experience, one must look at such estimates skeptically.  The actual amounts raised have normally been far less.  And one should expect that in particular now, given the underfunding of the IRS enforcement budget of recent years.

C.  Distributional Impacts

The above examined what is being proposed for separate portions of the US tax system.  These then translate into impacts on individuals by income level depending on how important those separate portions of the tax system are to those in each income group.  While such estimates are based on highly detailed data drawn from millions of tax returns, there is still a good deal of modeling work that needs to be done, for example, to translate impacts on corporate taxes into what this means for individuals who receive income (dividends and capital gains) from their corporate ownership.

The Tax Policy Center, an independent non-profit, provides such estimates, and their estimate of the impacts of the Republican tax plans (in this case the November 3 House version) has been discussed previously on this blog.  The JCT also provides such estimates, using a fundamentally similar model in structure (but different in the particulars).

Based on the November 15 version of the Senate Republican plan, the JCT estimated that the impacts on households (taxpayer units) would be as follows:

Overall Change in Taxes Due per Taxpayer Unit

Income Category

2019

2021

2023

2025

2027

Less than $10,000

-$21

-$5

$9

$11

$18

$10 to $20,000

-$49

$136

$180

$180

$307

$20 to $30,000

-$87

$138

$144

$170

$355

$30 to $40,000

-$288

-$97

-$16

-$10

$284

$40 to $50,000

-$496

-$275

-$197

-$187

$283

$50 to $75,000

-$818

-$713

-$607

-$610

$139

$75 to 100,000

-$1,204

-$1,150

-$962

-$994

-$38

$100 to $200,000

-$2,091

-$2,027

-$1,622

-$1,657

-$118

$200 to $500,000

-$6,488

-$6,319

-$5,176

-$5,510

-$462

$500 to $1,000,000

-$21,581

-$20,241

-$15,611

-$16,417

-$1,495

Over $1,000,000

-$58,864

-$48,175

-$21,448

-$25,111

-$8,871

Total – All Taxpayers

-$1,357

-$1,200

-$901

-$950

$57

Source:  Calculated from estimates of tax revenue distribution effects made by the staff of the Joint Committee on Taxation, publication JCX-58-17, November 16, 2017, of the November 15 version of the Republican Chairman’s proposed tax legislation.

By these estimates, each income group would, on average, enjoy at least some cut in taxes in 2019.  A number of the proposed tax measures are front-loaded, and it is likely that this structure is seen as beneficial by those seeking re-election in 2020.  But the cuts in 2019 vary from tiny ($21 for those earning $10,000 or less, and $49 for those earning $10,000 to $20,000), to huge ($21,581 for those earning $500,000 to $1,000,000, and $58,864 for those earning over $1,000,000).  However, from 2021 onwards, taxes due would actually rise for most of those earning $40,000 or less (or be cut by minor amounts).  And this is already true well before the assumed termination of many of the individual income tax measures in 2025.  With the plan as it now stands, in 2027 all those earning less than $75,000 would end up paying more in taxes (on average) under this supposed “middle-class tax cut” than they would if the law were left unchanged.

The benefits to those earning over $500,000 would, however, remain large, although also declining over time.

D.  Conclusion

The tax plan now going through Congress would provide very large cuts for the rich.  One can see this in the specific tax measures being proposed (with huge cuts in the portions of the tax system of most importance to the rich) and also in the direct estimates of the impacts by income group.  There are in addition numerous measures in the tax plan of interest to narrow groups, that are difficult to rationalize other than that they reflect what politically influential groups want.

The program, if adopted, would lead to a significantly less progressive tax system, and to a more complex one.  There would be a new category of income (pass-through income) receiving a special low tax rate, and hence new incentives for those who are well off to re-organize their compensation system when they can so that the incomes they receive would count as pass-through incomes.  While the law might try to set limits on these, past experience suggests that clever lawyers will soon find ways around such limits.

There are also results one would think most politicians would not advocate, such as the incentive to relocate corporate factories and activities to overseas.  They clearly do not understand the implications of what they have been and will be voting on.  This is not surprising, given the decision to try to rush this through before a full analysis and debate will be possible.  There have even been no hearings with independent experts at any of the committees.  And there is the blatant misrepresentation, such as that this is a “middle-class tax cut”, and that “taxes on millionaires will not be cut”.

If this is passed by Congress, in this way, there will hopefully be political consequences for those who chose nonetheless to vote for it.

Health Insurance Coverage is Improving, Especially in States that Have Not Tried to Block It

health-insurance-cover-2008-to-2015-by-medicaid-states-census-bureau-sept-2016

 

A.    Introduction

The US Census Bureau released on September 13 this year’s editions of three reports which normally come out at about this time:  Its report on Income and Poverty in the United States, its report on Health Insurance Coverage, and its Supplemental Poverty Measure report, which provides figures on poverty when government transfer programs are taken into account.  They all cover the period through 2015.

The reports show exceptionally strong improvements in a range of measures of income and well-being.  To start, real median household incomes rose by an estimated 5.2% in 2015. There has never before been such a large jump in real incomes since this series first started being reported in 1967.  Perhaps more importantly than the overall gains, the Census Bureau data also show that the gains were widespread across income groups (with the poorest 10% decile in fact seeing the largest gains) as well as across race and ethnic groups.  It was not only the rich who saw an improvement.

I should hasten to add that these results are from just one year, and that they follow far less satisfactory results over the last several years.  Real household incomes plummeted in the 2008 downturn in the last year of the Bush administration, and were flat or fell further in most years since.  It should also be recognized that the Census Bureau figures are based on household surveys, and thus that there will be statistical noise (as the Census Bureau emphasizes).  It remains to be seen whether the positive news will continue.  But with labor markets now at or close to levels generally considered to be full employment, and with real wages now rising, it is likely there has been an improvement also in 2016. But we will only know a year from now what the survey results will be.

The Health Insurance Coverage report found that health insurance coverage also improved significantly in 2015, as it had also in 2014 but importantly not in the years before.  The big change in 2014 was of course the coming into effect of the Affordable Care Act (ACA, or ObamaCare) reforms, with the introduction of the market exchanges on which the previously uninsured could purchase insurance at a reasonable price, as well as the expansion of Medicaid coverage in a number of states (but not all).  There are now over 20 million more Americans who have health insurance coverage than had it in 2013, before ObamaCare went into effect.

Not surprisingly, the reports received a good deal of news coverage.  It was the lead front page article of the Washington Post the next day, for example.  Not surprisingly also, the White House released a summary of some of the key, highly positive, findings.  But while the news reports focussed on the strong income gains, and many also noted the health insurance gains, I have not seen a chart such as that above which shows the gains in historical context, and with the Medicaid expansion states and non-expansion states shown separately.  This post will discuss that chart and what is going on behind it.

B.  The Gains in Health Insurance Coverage Under ObamaCare

The chart above shows the percentage share of the population without health insurance coverage in each year from 2008 to 2015, with this shown separately for those states where Medicaid was permitted to expand (27 states plus Washington, DC, with the status taken as of January 1, 2015) and for those states that did not allow Medicaid to expand (23 states). The figures were calculated from the underlying data tables (the “HIC” series) used in the Census Bureau Health Insurance Coverage report.  The data series used here comes from the American Community Survey (ACS), which has an extremely large sample size which permits a meaningful state by state breakdown.  It asks whether the individual was uninsured at the time of the interview.

The Health Insurance Coverage report also presents figures at the national level obtained from a different survey called the Current Population Survey – Annual Social and Economic Supplement (CPS ASEC), which is undertaken each Spring. This survey has a smaller sample size than the ACS, which is fine for national level estimates but which does not suffice for state by state breakdowns (as one needs when looking at Medicaid coverage by state).  It also asks the somewhat different question of whether the individual had health insurance cover for the entire previous year, rather than on the date of the interview.

The share of the US population without health insurance coverage fell sharply in 2014 and again in 2015.  Using figures from the ACS, it had fluctuated modestly in the period from 2008 through 2013, rising from 14.6% of the population in 2008 to 15.5% as unemployment hit its peak in 2010, and then recovering slowly to 14.5% by 2013.  It then dropped sharply to 11.7% in 2014 and to 9.4% in 2015.  Critics of ObamaCare asserted at the start that the reforms did not and would not lead to more Americans being covered by health insurance.  That was certainly not the case.  By 2015, there were 20.7 million more Americans with health insurance cover than had it in 2013.  This is far from minor, and can make an immense difference in a family’s life.

The CPS ASEC figures also show a sharp drop in the share of the population without health insurance, with these figures quoted in many of the news reports one might see. With its differing definition of who is not covered (for the entire year, rather than on the date of the interview as in the ACS), the shares are somewhat lower, at 9.1% in 2015.  It fell from a 13.3% share in 2013 and a 10.4% share in 2014 in these estimates of the share of the population who did not have health insurance over the entire year.

By whichever measure, health insurance cover expanded sharply once the ObamaCare reforms entered into effect.  By the ACS measure, the share of the population without health insurance fell from 14.5% of the population in 2013 to 9.4% two years later, or by 5.1% points.  It can be expected to fall further, although not to zero.  Certain groups in the population (including certain immigrant groups) are not eligible for purchasing insurance through the ObamaCare market exchanges, and thus the non-insured rate will never go to zero.  While the floor is not certain, many analysts set the figure at perhaps 4 or 5% of the population.  If so, then the improvement seen so far is approximately half of what might ultimately be achievable, provided politically imposed roadblocks are all removed.

C.  Medicaid Expansion

The chart also shows the shares of the population without health insurance separately for the states that expanded Medicaid coverage (supported by the ACA and an integral part of it) and those that did not. The system as designed under the ACA has that the working poor and lower income classes would obtain health insurance under Medicaid, with eligibility expanded from those with income up to generally 100% of the federal poverty line previously, to 133% from 2014 onwards.  Those with incomes higher than this would purchase insurance from the market exchanges, with a subsidy that phases out as incomes grow and is phased out entirely at 400% of the federal poverty line.  Thus the entire population, no matter how poor, would be able to obtain health insurance.

However, the Supreme Court decided that Medicaid expansion could not be made obligatory on the states even if the federal government is paying for it (as it is here). Rather, the states could choose whether or not to allow Medicaid to expand cover to include those making up to 133% of the federal poverty line.  It would be financially foolish for the states not to, as the federal government would cover 100% of the cost of the expanded coverage in the first several years, with this then phasing down to 90% of the additional cost from 2020 onwards.  But even with the states covering 10% of the cost from 2020, a net gain can be expected for the state budget due to the increased incomes of hospitals, doctors, nurses, and other health car suppliers who would now be providing care to the poor when they need it (and be compensated for it), and the state tax revenues that would be generated by such higher incomes. The states would also save by being able to reduce state payments made to cover a portion of the costs incurred by hospitals to provide health services to patients who were not able to pay for their treatments, due to a lack of health insurance.

Despite this, 23 states (as of January 2015) decided that the low income earners in their states would not be allowed to receive health insurance cover from Medicaid.  Note that these families must indeed be working to be able to have an income of 100% of the federal poverty line (of $24,300 in 2016 for a household of four).  Assuming one wage earner, working 40 hours a week for 52 weeks a year (no vacations), they would need to earn a wage of $11.68 per hour to earn this much, or well above the minimum wage of $7.25 per hour.  More likely there would be two income earners in such a household, each earning a wage rate of closer to the minimum wage, but likely not able to obtain full time employment of 40 hours a week for 52 weeks a year.  These households are not slackers, but rather are working hard to get by.

Yet these states are refusing to allow such households to obtain health insurance cover from Medicaid, despite a net financial benefit to their state budgets.  And since the Affordable Care Act was structured that such families would obtain health insurance coverage from Medicaid, and not purchased (with a partial subsidy assistance) through the health insurance market exchanges, they are now left with nothing.  These states have deliberately created a gap where their low income workers are effectively denied access to health insurance.

The reason these states have done this is of course political.  The 23 states (as of January 1, 2015) that had not permitted Medicaid to expand were states with Republican governors or Republican legislatures (or mostly both) that refused to allow Medicaid in their states to serve such families.  And as noted above, this was done even at financial cost to themselves.  Nebulous arguments were given that while the federal government would be paying for most or all of the costs in the near term, the federal government might reverse this later, due perhaps to budget pressures.  But there is no reason why such a reversal should be expected, nor why, if there were indeed such budget pressures, it would apply to Medicaid but not to other federally funded programs that those states are taking advantage of.  Furthermore, if this did indeed happen at some uncertain point in the future, the Medicaid programs in the state could be cut then, rather than now in anticipation that this might somehow happen at some unknown point in the unknown future.

As shown in the chart at the top of this post, the share of the population without health insurance cover fell to just 7.2% in 2015 in the 27 states (plus Washington, DC) that allowed Medicaid to expand, far below the 12.3% in those states that blocked that expansion.  Compared to 2013, before the ObamaCare reforms went into effect, this was a reduction of 5.6% points in the states that allowed Medicaid to expand, versus a reduction of 4.5% points in the states where the expansion was blocked.  Put another way, the share of the population without health insurance fell by 43% in the states that allowed Medicaid to expand, versus a fall of just 27% in the states that blocked it.

Furthermore, the far better improvement in the Medicaid expansion states was from a lower starting point in 2013 (of 12.8% of their population without health insurance, versus 16.7% in the states blocking Medicaid expansion).  One should expect that improvement becomes more difficult as one comes closer to the achievable ceiling in coverage.

But the chart also serves to show that the states blocking Medicaid expansion historically had a high share of their populations without health insurance.  These were conservative states, often relatively poor, with political establishments that did not exhibit great concern over the fact that a high share of their population could not get health insurance.  But not all were poor.  Indeed, the state with the absolute worst share of any state was oil-rich Texas, with 22.1% of its population without health insurance in 2013, and still 17.1% without it in 2015 (where both figures were the highest in the US in the respective years). Out of 50 states (plus Washington, DC), Texas was the worst.  This was a political choice, not an economic one.

It should also be noted that the reduction in the shares of uninsured in those states that allowed Medicaid to expand was not due solely to the increased number of Medicaid enrollees.  Between 2013 and 2015, those states saw 12.2 million of their citizens obtain health insurance cover.  Of these, 7.6 million came from increased enrollment under Medicaid, while 4.5 million came from other health insurance cover (including through the ObamaCare market exchanges).  And as noted above, they were starting from a point where a relatively high share of their citizens (compared to the states where Medicaid expansion was blocked) enjoyed some form of health insurance cover previously.

D.  The States That Allowed Medicaid to Expand Also Had Lower Premiums on ObamaCare Health Insurance Plans than on Company-Based Plans

There is also an interesting finding that the states that allowed Medicaid to expand not only saw greater improvements in the shares of their citizens who enjoyed health insurance cover, but also saw insurance premiums on their ObamaCare exchanges (as of 2016) which were lower than comparable company-sponsored plans in those states.

recent study by the Urban Institute (a non-profit think tank) found that for similar health insurance cover, the full prices (before subsidies) of health insurance purchased through the ObamaCare exchanges were 10% lower on average (at the national level), than the full prices of similar health insurance plans provided through employers. The calculations were made state by state, as costs varied by state, and varied widely.  But on average, the ObamaCare plans cost 10% less.

This may be come as a surprise to many.  The issue is that most employees do not know what the full cost of their company-sponsored health insurance plans in fact is.  The full cost includes not only what they pay directly, but also what they pay indirectly through the employer (which they typically never see) as part of their overall labor compensation package.  But it is part of their wages and a cost that must be covered.

The 10% lower cost is an average at the national level.  But the Urban Institute figures are calculated at the state level, and one can calculate from this how they vary between those states that expanded their Medicaid coverage and those states that blocked it. The results are interesting.  The simple unweighted averages (I did not have the underlying data necessary to calculate a weighted average properly) were:

Health Insurance Plan Costs:  ObamaCare Exchanges vs. Company Based

Unweighted averages

All States      

 -8%

Medicaid Expanded

-15%

Medicaid Not Expanded

   0%

The unweight average lower cost of the ObamaCare plans was 8% nationally.  This is different from the 10% figure the Urban Institute cited because the lower costs were especially large in some of the larger states, such as New York, Illinois, Pennsylvania, Michigan, and Ohio (all of which had lower costs of 18% or more).  In the unweighted averages, these larger states are weighted the same as smaller states.

But what is especially interesting is that the (unweighted) average lower cost of the ObamaCare plans compared to company based plans was 15% in the states that approved Medicaid expansion but was no different on average in the states that blocked Medicaid expansion.

Why would this be?  It was probably not due to the Medicaid expansion itself.  One would expect Medicaid expansion would lead to lower health insurance costs for those obtaining health insurance.  The reason is that hospitals and other health service providers will have lower costs due to less uncompensated care of patients without health insurance coverage (as more would have Medicaid coverage), and one can expect that these lower costs would then be reflected in lower health insurance costs for those who do pay. However, this should affect health insurance costs of policies purchased through the ObamaCare exchanges and company-based policies similarly, and hence would not likely affect the ratio in cost between the two.

However, the Medicaid expansion states were also the ones that encouraged competitive ObamaCare market exchanges to be established.  They did not seek to block these markets or keep them from functioning well.  They encouraged competition rather than did whatever they could to hinder it.

It was likely due to this greater degree of competition in those states that supported, rather than hindered, the ObamaCare exchanges that explains the lower costs in those states. This is also consistent with the fact noted above that many of the larger states saw especially low costs (relative to company-based plans) than were observed among the relatively smaller states.  The larger states will in general see greater competition, and competition drives down prices.

E.  ObamaCare Issues Remain

One can no longer dispute that ObamaCare has succeeded in its primary goal of making it possible for a higher share of the population to obtain the security of health insurance coverage.  But this certainly does not mean there are no issues with ObamaCare.

Republicans openly acknowledge that they continue to do whatever they can to block the expansion of access to health insurance under ObamaCare.  And these efforts to hinder ObamaCare have achieved some success.  As noted above, states that blocked Medicaid expansion have seen less of a reduction in their uninsured populations than was achieved in the states that allowed that expansion.  But the efforts to block access to ObamaCare went beyond blocking Medicaid.  Most of these states also decided not to implement directly the ObamaCare market exchanges in their states.  The Affordable Care Act envisioned that to best allow local control and adaptation to a state’s particular circumstances, state level authorities would be allowed and indeed encouraged to establish such exchanges.  Fortunately, the law also included a back-up provision that should a state choose not to establish such an exchange, the federal government could do it to allow the citizens of that state access to an affordable health insurance plan.  This was not without difficulties; recall the initial failure of the federal level computer systems when enrollment opened in October 2013 and the system was overwhelmed.

More recently, several of the larger health insurers have decided to withdraw from some of the markets in which they had previously offered health insurance plans on the ObamaCare market exchanges.  Most recently, Aetna announced in August that it would withdraw in 2017 from 11 of the 15 states where it had been offering such plans.  This followed earlier announcements by UnitedHealth and Humana that they also would be scaling back offerings significantly.  This will reduce competition among the insurers in a number of markets around the country, limiting the options enrollees in those markets will have.  Indeed, in some counties around the country there will be only one insurer offering coverage through the exchanges, and (unless something is now done) one county in Arizona where there will be no such insurer offering coverage through the exchanges.

The issues could certainly be addressed, if there is the will.  All major new social programs, including Medicare and Social Security were fine-tuned through new legislation following their launch to address issues that developed.  And this was done on a bipartisan basis. The problem now is that the Republican Party, for political reasons, is doing what it can to block any such adjustments, with the openly stated aim of trying to destroy ObamaCare.

It is still to be seen whether these efforts will succeed.  If they do, the US will revert to its previous system, with millions of Americans denied access to health insurance and with sharply rising health care costs that outpaced general inflation for decades.

Taxes to Pay for Highways: A Switch from the Tax on Gallons of Fuel Burned to a Tax on Miles Driven Would Be Stupid

Impact of Switching from Fuel Tax on Gallons Burned to Tax on Miles Driven

A.  Introduction

According to a recent report in the Washington Post, a significant and increasing number of state public officials and politicians are advocating for a change in the tax system the US uses to support highway building and maintenance.  The current system is based on a tax on gallons of fuel burned, and the proposed new system would be based on the number of miles a car is driven.  At least four East Coast states are proposing pilots on how this might be done, some West Coast states have already launched pilots, and states are applying for federal grants to consider the change.  There is indeed even a lobbying group based in Washington now advocating it:  The Mileage-Based User Fee Alliance.

There is no question that the current federal gas tax of 18.4 cents per gallon of gasoline is woefully inadequate.  It was last changed in 1993, 23 years ago, and has been kept constant in nominal terms ever since.  With general prices (based on the CPI) now 65% higher, 18.4 cents now will only buy 11.2 cents at the prices of 1993, a decline of close to 40%.  As a result, the Highway Trust Fund is terribly underfunded, and with all the politics involved in trying to find other sources of funding, our highways are in terrible shape. Basic maintenance is simply not being done.

An obvious solution would be simply to raise the gas tax back at least to where it was before in real terms.  Based on where the tax was when last set in 1993 and on the CPI for inflation since then, this would be 30.3 cents per gallon now, an increase of 11.9 cents from the current 18.4 cents per gallon.  Going back even further, the gasoline tax was set at 4 cents per gallon in 1959, to fund the construction of the then new Interstate Highway system (as well as for general highway maintenance).  Adjusting for inflation, that tax would be 32.7 cents per gallon now.  Also, looking at what the tax would need to be to fund adequately the Highway Trust Fund, a Congressional Budget Office report issued in 2014 estimated that a 10 to 15 cent increase (hence 28.4 cents to 33.4 cents per gallon) would be needed (based on projections through 2024).

These fuel tax figures are all similar.  Note also that while some are arguing that the Highway Trust Fund is underfunded because cars are now more fuel efficient than before, this is not the case.  Simply bringing the tax rate back in real terms to where it was before (30.3 cents based on the 1993 level or 32.7 cents based on the 1959 level) would bring the rate to within the 28.4 to 33.4 cents range that the CBO estimates is needed to fully fund the Highway Trust Fund.  The problem is not fuel efficiency, but rather the refusal to adjust the per gallon tax rate for inflation.

But Congress has refused to approve any such increase.  Anti-tax hardliners simply refuse to consider what they view as an increase in taxes, even though the measure would simply bring them back in real terms to where they were before.  And it is not even true that the general population is against an increase in the gas tax.  According to a poll sponsored by the Mineta Transportation Institute (a transportation think tank based at San Jose State University in California), 75% of those polled would support an immediate increase in the gas tax of 10 cents a gallon if the funds are dedicated to maintenance of our streets, roads, and highways (see the video clip embedded in the Washington Post article, starting at minute 3:00).

In the face of this refusal by Congress, some officials are advocating for a change in the tax, from a tax per gallon of fuel burned to a new tax per mile each car is driven.  While I do not see how this would address the opposition of the anti-tax politicians (this would indeed be a totally new tax, not an adjustment in the old tax to keep it from falling in real terms), there appears to be a belief among some that this would be accepted.

But even if such a new tax were viewed as politically possible, it would be an incredibly bad public policy move to replace the current tax on fuel burned with such a tax on miles driven.  It would in essence be a tax on fuel efficiency, with major distributional (as well as other) consequences, favoring those who buy gas guzzlers.  And as it would encourage the purchase of heavy gas guzzlers (relative to the policy now in place), it would also lead to more than proportional damage to our roads, meaning that road conditions would deteriorate further rather than improve.

This blog post will discuss why such consequences would follow.  To keep things simple, it will focus on the tax on gasoline (which I will sometimes simply referred to as gas, or as fuel).  There are similar, but separate taxes, on diesel and other fuels, and their levels should be adjusted proportionally with any adjustment for gasoline.  There is also the issue of the appropriate taxes to be paid by trucks and other heavy commercial vehicles.  That is an important, but separate, issue, and is not addressed here.

B.  The Proposed Switch Would Penalize Fuel Efficient Vehicles

The reports indicate that the policy being considered would impose a tax of perhaps 1.5 cents per mile driven in substitution for the current federal tax of 18.4 cents per gallon of gas burned (states have their own fuel taxes in addition, with these varying across states). For the calculations here I will take the 1.5 cent figure as the basis for the comparisons, even though no specific figure is as yet set.

First of all, it should be noted that at the current miles driven in the country and the average fuel economy of the stock of cars being driven, a tax of 1.5 cents per mile would raise substantially more in taxes than the current 18.4 cents per gallon of gas.  That is, at these rates, there would be a substantial tax increase.

Using figures for 2014, the average fuel efficiency (in miles per gallon) of the light duty fleet of motor vehicles in the US was 21.4 miles per gallon, and the average miles driven per driver was 13,476 miles.  At a tax of 1.5 cents per mile driven, the average driver would pay $202.14 (= $.015 x 13,476) in such taxes per year.  With an average fuel economy of 21.4 mpg, such a driver would burn 629.7 gallons per year, and at the current fuel tax of 18.4 cents per gallon, is now paying $115.87 (= $.184 x 629.7) in gas taxes per year. Hence the tax would rise by almost 75% ($202.14 / $115.87).  A 75% increase would be equivalent to raising the fuel tax from the current 18.4 cents to a rate of 32.1 cents per gallon.  While higher tax revenues are indeed needed, why a tax on miles driven would be acceptable to tax opponents while an increase in the tax per gallon of fuel burned is not, is not clear.

But the real reason to be opposed to a switch in the tax to miles driven is the impact it would have on incentives.  Taxes matter, and affect how people behave.  And a tax on miles driven would act, in comparison to the current tax on gallons of fuel burned, as a tax on fuel efficiency.

The chart at the top of this post shows how the tax paid would vary across cars of different fuel efficiencies.  It would be a simple linear relationship.  Assuming a switch from the current 18.4 cents per gallon of fuel burned to a new tax of 1.5 cents per mile driven, a driver of a highly fuel efficient car that gets 50 miles per gallon would see their tax increase by over 300%!  A driver of a car getting the average nation-wide fuel efficiency of 21.4 miles per gallon would see their tax increase by 75%, as noted above (and as reflected in the chart).  In contrast, someone driving a gas guzzler getting only 12 miles per gallon or less, would see their taxes in fact fall!  They would end up paying less under such a new system based on miles driven than they do now based on gallons of fuel burned.  Drivers of luxury sports cars or giant SUVs could well end up paying less than before, even with rates set such that taxes on average would rise by 75%.

Changing the tax structure in this way would, with all else equal, encourage drivers to switch from buying fuel efficient cars to cars that burn more gas.  There are, of course, many reasons why someone buys the car that they do, and fuel efficiency is only one.  But at the margin, changing the basis for the tax to support highway building and maintenance from a tax per gallon to a tax on miles driven would be an incentive to buy less fuel efficient cars.

C.  Other Problems

The change to a tax on miles driven from the tax on gallons of fuel burned would have a number of adverse effects:

a)  A Tax on Fuel Efficiency:  As noted above, this would become basically a tax on fuel efficiency.  More fuel efficient cars would pay higher taxes relative to what they do now, and there will be less of an incentive to buy more fuel efficient cars.  There would then be less of an incentive for car manufacturers to develop the technology to improve fuel efficiency.  This is what economists call a technological externality, and we all would suffer.

b)  Heavier Vehicles Cause Far More Damage to the Roads:  Heavier cars not only get poorer gas mileage, but also tear up the roads much more, leading to greater maintenance needs and expense.  Heavier vehicles also burn more fuel, but there is a critical difference.  As a general rule, vehicles burn fuel in proportion with their weight: A vehicle that weighs twice as much will burn approximately twice as much fuel.  Hence such a vehicle will pay twice as much in fuel taxes (when such taxes are in cents per gallon) per mile driven.

However, the heavier vehicle also cause more damage to the road over time, leading to greater maintenance needs.  And it will not simply be twice as much damage.  A careful early study found that the amount of damage from a heavier vehicle increases not in direct proportion to its weight, but rather approximately according to the fourth power of the ratio of the weights.  That is, a vehicle that weighs twice as much (for the same number of axles distributing the weight) will cause damage equal to 2 to the fourth power (=16) times as much as the lighter vehicle.  Hence if they were to pay taxes proportionate to the damage they do, a vehicle that is twice as heavy should pay 16 times more in taxes, not simply twice as much.

(Note that some now argue that the 2 to the fourth power figure found before might be an over-estimate, and that the relationship might be more like 2 to the third power.  But this would still imply that a vehicle that weighs twice as much does 8 times the damage (2 to the third power = 8).  The heavier vehicle still accounts for a grossly disproportionate share of damage to the roads.)

A tax that is set based on miles driven would tax heavy and light vehicles the same.  This is the opposite of what should be done:  Heavy vehicles cause far more damage to the roads than light vehicles do.  Encouraging heavy, fuel-thirsty, vehicles by switching from a tax per gallon of fuel burned to a tax per mile driven will lead to more road damage, and proportionately far more cost than what would be collected in highway taxes to pay for repair of that damage.

c)  Impact on Greenhouse Gases:  One also wants to promote fuel efficiency because of the impact on greenhouse gases, and hence global warming, from the burning of fuels. By basic chemistry, carbon dioxide (CO2) is a direct product of fuel that is burned.  The more fuel that is burned, the more CO2 will go up into the air and then trap heat. Economists have long argued that the most efficient way to address the issue of greenhouse gases being emitted would be to tax them in proportion to the damage they do.  A tax on gallons of fuel that are burned will do this, while a tax on miles driven (and hence independent of the fuel efficiency of the vehicle) will not.

An interesting question is what level of gasoline tax would do this.  That is, what would the level of fuel tax need to be, for that tax to match the damage being done through the associated emission of CO2.  The EPA has come up with estimates of what the social cost of such carbon emissions are (and see here for a somewhat more technical discussion of its estimates).  Unfortunately, given the uncertainties in any such calculations, as well as uncertainty on what the social discount rate should be (needed to discount costs arising in the future that follow from emitting greenhouse gases today), the cost range is quite broad. Hence the EPA presents figures for the social cost of emitting CO2 using expected values at alternative social discount rates of 2.5%, 3%, and 5%, as well as from a measure of the statistical distribution of one of them (the 95th percentile for the 3% discount rate, meaning there is only an estimated 5% chance that the cost will be higher than this).  The resulting costs per metric ton of CO2 emitted then range from a low of $11 for the expected value (the 50th percentile) at the 5% discount rate, $36 at the expected value for the 3% discount rate, and $56 for the expected value for the 2.5% discount rate, to $105 for the 95th percentile at a 3% discount rate (all for 2015).

With such range in social costs, one should be cautious in the interpretation of any one. But it may still be of interest to calculate how this would translate into a tax on gasoline burned by automobiles, to see if the resulting tax is “in the ballpark” of what our fuel taxes are or should be.  Every gallon of gasoline burned emits 19.64 pounds of CO2.  There are 2,204.62 pounds in a metric ton, so one gallon of gas burned emits 0.00891 metric tons of CO2.  At the middle social cost of $36 per metric ton of CO2 emitted (the expected value for the 3% social discount rate scenario), this implies that a fuel tax of 32.1 cents per gallon should be imposed.  This is surprisingly almost precisely the fuel tax figure that all the other calculations suggest is warranted.

d)  One Could Impose a Similar Tax on Electric Cars:  One of the arguments of the advocates of a switch from taxes on fuel burned to miles driven is that as cars have become more fuel efficient, they pay less (per mile driven) in fuel taxes.  This is true.  But as generally lighter vehicles (one of the main ways to improve fuel economy) they also cause proportionately far less road damage, as discussed above.

There is also an increasing share of electric, battery-powered, cars, which burn no fossil fuel at all.  At least they do not burn fossil fuels directly, as the electricity they need to recharge their batteries come from the power grid, where fossil fuels dominate.  But this is still close to a non-issue, as the share of electric cars among the vehicles on US roads is still tiny.  However, the share will grow over time (at least one hopes).  If the share does become significant, how will the cost of building and maintaining roads be covered and fairly shared?

The issue could then be addressed quite simply.  And one would want to do this in a way that rewards efficiency (as different electric cars have different efficiencies in the mileage they get for a given charge of electricity) rather than penalize it.  One could do this by installing on all electric cars a simple meter that keeps track of how much it receives in power charges (in kilowatt-hours) over say a year.  At an annual safety inspection or license renewal, one would then pay a tax based on that measure of power used over the year.  Such a meter would likely have a trivial cost, of perhaps a few dollars.

Note that the amounts involved to be collected would not be large.  According to the 2016 EPA Automobile Fuel Economy Guide (see page 5), all-electric cars being sold in the US have fuel efficiencies (in miles per gallon equivalent) of over 100 mpg, and as high as 124 mpg.  These are on the order of five times the 21.4 average mpg of the US auto stock, for which we calculated that the average tax to be paid would be $202.  Even ignoring that the electric cars will likely be driven for fewer miles per year than the average car (due to their shorter range), the tax per year commensurate with their fuel economy would be roughly $40.  This is not much.  It is also not unreasonable as electric cars are kept quite light (given the limits of battery technology) and hence do little road damage.

e)  There Are Even Worse Policies That Have Been Proposed:  As discussed above, there are many reasons why a switch from a tax on fuel burned to miles driven would be a bad policy change.  But it should be acknowledged that some have proposed even worse. One example is the idea that there should be a fixed annual tax per registered car that would fund what is needed for highway building and maintenance.  Some states in fact do this now.

The amounts involved are not huge.  As was calculated above, at the current federal gasoline tax of 18.4 cents per gallon, the driver of a car that gets the average mileage (of 21.4 mpg) for the average distance a year (of 13,476 miles) will pay $115.87 a year.  If the fuel tax were raised to 32.1 cents per gallon (or equivalently, if there were a tax of 1.5 cents per mile driven), the average tax paid would be still just $202.14 per year.  These are not huge amounts.  One could pay them as part of an annual license renewal.

But the tax structured in this way would then be the same for a driver who drives a fuel efficient car or a gas guzzler.  And it would be the same for a driver who drives only a few miles each year, or who drives far more than the average each year.  The driver of a heavy gas guzzler, or one who drives more miles each year than others, does more damage to the roads and should pay more to the fund that repairs such damage and develops new road capacity.  The tax should reflect the costs they are imposing on society, and a fixed annual fee does not.

f)  The Cost of Tax Collection Needs to be Recognized:  Finally, one needs to recognize that it will cost something to collect the taxes.  This cost will be especially high for a tax on miles driven.

The current system, of a tax on fuel burned, is efficient and costs next to nothing to collect.  It can be charged at the point where the gasoline and other fuels leaves in bulk from the refinery, as all of it will eventually be burned.  While the consumer ultimately pays for the tax when they pump their gas, the price being charged at the pump simply reflects the tax that had been charged at an earlier stage.

In contrast, a tax on miles driven would need to be worked out at the level of each individual car.  And if the tax is to include shares that are allocating to different states, the equipment will need to keep track of which states the car is being driven in.  As the Washington Post article on a possible tax on miles driven describes, experiments are underway on different ways this might be done.  All would require special equipment to be installed, with a GPS-based system commonly considered.

Such special equipment would have a cost, both up-front for the initial equipment and then recurrent if there is some regular reporting to the center (perhaps monthly) of miles driven.  No one knows right now what such a system might cost if it were in mass use, but one could easily imagine that a GPS tracking and reporting system might cost on the order of $100 up front, and then several dollars a month for reporting.  This would be a significant share of a tax collection that would generate an average of just $202 per driver each year.

There is also the concern that any type of GPS system would allow the overseers to spy on where the car was driven.  While this might well be too alarmist, and there would certainly be promises that this would not be done, some might not be comforted by such promises.

D.  Conclusion

While one should always consider whether given policies can be changed for the better, one needs also to recognize that often the changes proposed would make things worse rather than better.  Switching the primary source of funding for highway building and maintenance from a tax on fuel burned to a tax on miles driven is one example.  It would be a stupid move.

There is no doubt that the current federal tax on gasoline of 18.4 cents per gallon is too low.  The result is insufficient revenues for the Highway Trust Fund, and we end up with insufficient road capacity and roads that are terribly maintained.

What I was surprised by in the research for this blog post was finding that a wide range of signals all pointed to a similar figure for what the gasoline tax should be. Specifically:

  1. The 1959 gas tax of 4 cents per gallon in terms of current prices would be 32.7 cents per gallon;
  2. The 1993 gas tax of 18.4 cents per gallon in terms of current prices would be 30.3 cents per gallon;
  3. The proposal of a 1.5 cent tax per mile driven would be equivalent (given current average car mileage and the average miles driven per year) to 32.1 cents per gallon;
  4. The tax to offset the social cost of greenhouse gas emissions from burning fuel would be (at a 3% social discount rate) 32.1 cents per gallon.
  5. The Congressional Budget Office projected that the gasoline tax needed to fully fund the Highway Trust Fund would be in the range of 28.4 to 33.4 cents per gallon.

All these point in the same direction.  The tax on gasoline should be adjusted to between 30 and 33 cents per gallon, and then indexed for inflation.

The Rate of Return on Funds Paid Into Social Security Are Actually Quite Good

Social Security Real Rates of Return - Various Scenarios

 

A.  Introduction

The rate of return earned on what is paid into our Social Security accounts is actually quite good.  It is especially good when one takes into account that these are investments in safe assets, and thus that the proper comparison should be to the returns on other safe assets, not risky ones.  Yet critics of Social Security, mostly those who believe it should be shut down in its current form with some sort of savings plan invested through the financial markets (such as a 401(k) plan) substituted for it, often assert that the returns earned on the pension savings in Social Security are abysmally poor.

These critics argue that by “privatizing” Social Security, that is by shifting to individual plans invested through the financial markets, returns would be much higher and that thus our Social Security pensions would be “rescued”.  They assert that by privatizing Social Security investments, the system will be able to provide pensions that are either better than what we receive under the current system, or that similar pensions could be provided at lower contribution (Social Security tax) rates.

There are a number of problems with this.  They include that risks of poor financial returns (perhaps due, for example, to a financial collapse such as that suffered in 2008 in the last year of the Bush administration, when many Americans lost much or all of their retirement savings) would then be shifted on to individuals.  Individuals are not in a good position to take on such risks.  Individuals are also not financial professionals, nor normally in a good position to judge the competency of financial professionals who offer them services.  They also often underestimate the impact of high and compounding fees in depleting their savings over time.  For all these reasons, such an approach would serve as a bad substitute for the Social Security system such as we have now, which is designed to provide at least a minimum pension that people can rely on in their old age, with little risk.

But there is also a more fundamental problem with this approach.  It presumes that returns in the financial markets will in general be substantially higher than returns that one earns on what we pay into the Social Security system.  This blog post will show that this is simply not true.

The post looks at what the implicit rates of return are under several benchmark cases for individuals.  We pay into Social Security over our life time, and then draw down Social Security pensions in our old age.  The returns will vary for every individual, depending on their specific earnings profile (how much they earn in each year of their working career), their age, their marital situation, and other factors.  Hence there will be over 300 million different cases, one for each of the over 300 million Americans who are either paying into Social Security or are enjoying a Social Security pension now.  But by selecting a few benchmarks, and in particular extreme cases in the direction of where the returns will be relatively low, we can get a sense of the range of what the rates of return normally will be.

The chart at the top of this post shows several such cases.  The rest of this post will discuss each.

B.  Social Security Rates of Return Under Current Tax and Benefit Rates

The scenarios considered are all for an individual who is assumed to work from age 22 to age 65, who then retires at 66.  The individual is assumed to have reached age 65 in 2013 (the most recent year for which we have all the data required for the calculations), and hence reached age 62 in 2010 and was born in 1948.  The historical Social Security tax rates, the ceiling on wages subject to Social Security tax, the wage inflation factors used by Social Security to adjust for average wage growth, and the median earnings of workers by year, are all obtained from the comprehensive Annual Statistical Supplement to the Social Security Bulletin – 2014 (published April 2015).  Information on the parameters needed to calculate what the Social Security pension payments will be are also presented in detail in this Statistical Supplement, or in a more easy-to-use form for the specific case of someone reaching age 62 in 2010 in this publication of the Social Security Administration.  It is issued annually.

The Social Security pension for an individual is calculated by first taking the average annual earnings (as adjusted for average wage growth) over the 35 years of highest such earnings in a person’s working career.  For someone who always earned the median wage who reached age 62 in 2010, this would work out to $2,290 per month. The monthly pension (at full retirement age) would then be equal to 90% of the first $761, 32% of the earnings above this up to $4,586 per month, and then (if any is left, which would not be the case in this example of median earnings) 15% of the amount above $4,586.  Note the progressivity in these rates of 90% for the initial earnings, then 32%, and finally 15% for the highest earnings.  The monthly Social Security pension will then be the sum of these three components.  Since it is then adjusted for future inflation (as measured by the CPI), we do not need to make any further adjustments to determine the future pension payments in real terms.  The pensions will then be paid out from age 66 until the end of their life, which we take to be age 84, the current average life expectancy for someone who has reached the age of 65.

The historical series of payments made into the Social Security system through Social Security taxes (for Social Security Old-Age pensions only, and so excluding the taxes for Disability insurance and for Medicare) are then calculated by multiplying earnings by the tax rate (currently 10.6%, including the shares paid by both worker and employer).  The stream of payments are then put in terms of 2010 dollars using the historical CPI series from the Bureau of Labor Statistics.

We can thus calculate the real rates of return on Social Security pensions under various scenarios.  The first set of figures (lines A-1) in the chart above are for a worker whose earnings are equal to what median wages were throughout his or her working life.  (A table with the specific numbers on the rates of return is provided at the bottom of this post, for those who prefer a numerical presentation.)  The individual paid into the Social Security pension system when working, and will now draw a Social Security pension while in retirement.  One can calculate the real rate of return on this stream of payments in and then payments out, and in such a scenario for a single worker earning median wages throughout his or her career who retired at age 66 in 2014, the real rate of return works out to be 2.9%.  If the person is married, with a spouse receiving the standard spousal benefit, the real rate of return is 4.1%.

Such rates of return are pretty good, especially on what should be seen as a safe asset (provided the politicians do not kill the system).  Indeed, as discussed in an earlier post on this blog, the real rate of return (before taxes) on an investment in the S&P500 stock market index over the 50 year period 1962 to 2012, would have been just 2.9% per annum assuming fees on 401(k) type retirement accounts of 2.5% (which is typical once one aggregates the fees at all the various levels – see the discussion in section E.3 of this blog post).  But investing in the stock market, even in a broad based index such as the S&P500, is risky due to the volatility.  Retirement accounts in 401(k)’s are generally a mix of equity investments, fixed income securities (bonds of various maturities, CDs, and similar instruments), and cash.  Based on the recent average mix seen in 401(k)’s, and for the same 50 year period of 1962 to 2012, the average real rate of return achieved after the fees typically charged on such accounts would only have been 1.2%.  Social Security for a worker earning median wages is far better.

As noted above, there is a degree of progressivity in the system, as higher income earners will receive only a smaller boost in their pension (at the 15% rate) from the higher end of their earnings.  Thus the rates of return in Social Security for high income earners will be less.  The rates of return they will earn are shown on lines A-2 of the chart.  This extreme case is calculated for a worker who is assumed to have earned throughout his or her entire work life an amount equal to the maximum ceiling on wages subject to Social Security tax (which was $113,700 in 2013).  Note also that anyone earning even more than this will have the same rates of return, as they will not be paying any more into the Social Security system (it is capped at the wage ceiling subject to tax) and hence also not withdrawing any more (or less) in pension.

Such high income earners will nonetheless still see a positive real rate of return on their Social Security contributions, of 1.4% for a single earner and 2.8% if married receiving a spousal benefit.  That is, while there is some progressivity in the Social Security system, it is not such that the returns turn negative.  And the returns achieved are still better than what typical 401(k) retirement accounts earn.

One should also take into account that high income earners are living longer than low income earners.  Indeed, the increase in life expectancies have been substantial in the last 30 years for high income earners, but only modest for those in the bottom half of the earnings distribution.  While I do not have data on what the life expectancies are for a person whose earnings have been at the absolute top of the Social Security wage ceiling over the course of their careers, for the purposes here it was assumed their life expectancy (for someone who has reached age 65) would be increased to age 90 from the age of 84 for the overall population.

In such a scenario, the real rates of return for someone who paid into the Social Security system always at the wage ceiling over their entire life time and then drew a Social Security pension up to age 90 would be 2.2% if single and 3.4% if married with a standard spousal benefit.  These are far better than typical 401(k) returns, and indeed are quite good in comparison to an investment in any safe asset (once one takes into account fees).

C.  Social Security Rates of Return Assuming Higher Social Security Tax Rates

The rates of return calculated so far have been based on what the actual historical Social Security tax rates have been, and what the current benefit formula would determine for future pensions.  But as most know, at current tax and benefit rates the Social Security Trust Fund is projected to be depleted by about 2034 according to current estimates.  The reason is that life expectancies are now longer (which is a good thing), but inadequate adjustments have been made in Social Security tax rates to allow for pay-outs which will now need to cover longer lifetimes.  The problem has been gridlock in Washington, where an important faction of politicians opposed to Social Security are able to block any decision on how to pay for longer life expectancies.

There are a number of ways to ensure Social Security could be adequately funded.  One option, which I would recommend, would be simply to lift the ceiling on wages subject to Social Security tax (which was $113,700 in 2013, $118,500 in 2015, and will remain at $118,500 in 2016).  As discussed in section E.2 of this earlier blog post, it turns out that this alone should suffice to ensure the Social Security Trust Fund remains adequate for the foreseeable future.  The extra funding needed is an estimated 19.4% over what is collected now (based on calculations from an earlier post on this blog, but with data now a few years old), and it turns out that ending the wage ceiling would provide this.  At the ceiling on wages subject to Social Security tax of $113,700 in 2013, the share of workers earning at this ceiling or more was just 6.1%, but due to the skewed distribution of income in favor of the rich, untaxed wages in excess of the ceiling accounted for 17.3% of all wages paid.  That is, Social Security taxes were being paid on only 82.7% of all wages.  If the taxes were instead paid on the full 100%, Social Security would be collecting 21% more (= 100.0 / 82.7).

The extremely rich would then pay Social Security taxes at the same rate as most of the population, instead of something lower.  It should also be noted that it is the increase in life expectancy of those at the upper end of the income distribution which is driving the Social Security system into deficit at the current tax rates, as they are the ones living longer while those in the lower part of the income distribution are not.  Thus it is fair that those who will be drawing a Social Security pension for a longer period should be those who should be called on to pay more into the system.

To be highly conservative, however, for the rate of return calculations being discussed here I have assumed that the general Social Security tax rate will be increased by 19.4% on all wages below the ceiling, while the ceiling remains where it has been.  These calculations are for historical scenarios, where the purpose is to determine what the rates of return on payments into Social Security would have been had the tax rates been 19.4% higher on all, to provide for a fully funded system.  Finally, note that while these scenarios assume a higher Social Security tax rate historically, they also set the future pension benefits to be paid out to be the same as what they would be under the current benefit rates.  That is, the pay-out formulae would need to be changed to leave benefits the same despite the higher taxes being paid into the system.

The real rates of return would then be as shown in Panel B of the chart above.  While somewhat less than before, the real returns are still substantial, and still normally better than what is earned in a typical 401(k) plan.  The returns for someone earning at the median wage throughout their career will now be 2.4% if single and 3.6% if married (0.5% points less than before).  The returns for someone earning at or above the ceiling for wages subject to Social Security taxes would now be earning at the real rate of 0.8% if single and 2.2% if married for the age 84 life expectancy (0.6% points less than before), or 1.6% and 2.9% (for single and married) if the life expectancy of such high earners is in fact age 90 (also 0.6% points less, before round-off).

The real rates of return all remain positive, and generally good compared to what 401(k)’s typically earn.

D.  Conclusion

As noted above, the actual profile of Social Security taxes paid and pension received will vary by individual.  No two cases will be exactly alike.  But the calculations here indicate that for someone with median earnings, and still even in the extreme case of someone with very high earnings (where a degree of progressivity in the system will reduce the returns), the rates of return earned on what is paid into and then taken out of the Social Security system are actually quite good.  They generally are better than what is earned in a typical 401(k) account (after fees), and indeed often better than what would earn in a pure equity investment of the S&P500 index (and without the risk and volatility of such an investment).

Social Security is important and has become increasingly important.  Due to the end of many traditional defined benefit pension plans, with a forced switch to 401(k) plans or indeed often to nothing at all from the employer, Social Security now accounts (for those aged 65 or older) for a disturbingly high share on the incomes of many of the aged. Specifically, Social Security now accounts for half or more of total income for two-thirds of all those age 65 or older, and accounts for 100% of their income for one-quarter of them. And for the bottom 40% of this population, Social Security accounted for 90% or more of their total income for three-quarters of them, and 100% of their income for over half of them.

The problem is not in the Social Security system itself.  It is highly efficient, with an expense ratio in 2014 of just 0.4% of benefits paid.  Private 401(k) plans, with typical expenses of 2.5% of assets (not benefits) each year will have expenses over their life time that are 90 times as great as what Social Security costs to run.  And as seen in this post, the return on individual Social Security accounts are quite good.

The problem that Social Security faces is rather that with longer life expectancies (most importantly for those of higher income), the Social Security taxes being paid are no longer sufficient to cover the payouts to cover these longer lifetimes.  They need to be adjusted. There are several options, and my recommendation would be to start by ending the ceiling on wages subject to Social Security taxes.  This would suffice to solve the problem.  But one could go further.  As discussed in an earlier blog post (see Section E.2), not only should all wages be taxed equally, but one should extend this to taxing all forms of income equally (i.e. income from wealth as well as income from wages).  If one did this, one could then either cut the Social Security tax rate sharply, or raise the Social Security benefits that could be paid, or (and most likely) some combination of each.

But something needs to be done, or longer life spans will lead the Social Security Trust Fund to run out by around 2034.  The earlier this is resolved the better, both to ensure less of a shock when the change is finally made (as it could then be phased in over time) and for equity reasons (as it is those paying in now who are not adequately funding the system for what they will eventually drawdown).

 

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Annex:  Summary Table

Real Rates of Return from Social Security Old-Age Taxes and Benefits

A)  Social Security Scenarios – Current Rates

  1)  Earnings at Median Throughout Career

   a)  Single

2.9%

   b)  Married

4.1%

  2)  Earnings at Ceiling Throughout Career

   a)  Single

1.4%

   b)  Married

2.8%

  3)  Earnings at Ceiling, and Life Expectancy of 90

   a)  Single

2.2%

   b)  Married

3.4%

B)  Social Security with 19.4% higher tax rate

  1)  Earnings at Median Throughout Career

   a)  Single

2.4%

   b)  Married

3.6%

  2)  Earnings at Ceiling Throughout Career

   a)  Single

0.8%

   b)  Married

2.2%

  3)  Earnings at Ceiling, and Life Expectancy of 90

   a)  Single

1.6%

   b)  Married

2.9%

C)  Comparison to 401(k) Vehicles

  1)  S&P500 after typical fees

2.9%

  2)  Average 401(k) mix after typical fees

1.2%

Facts vs. Polemics on Unauthorized Immigration of Mexicans to the US

Stock of Mexican Unauthorized Immigrants in the US, 1995 to 2014, #2

Annual Net Flow of Mexican Unauthorized Immigrants to US, 1996 to 2014

In the heated rhetoric of the current Republican presidential campaign, one would think that the US is being flooded by illegal immigrants from Mexico, slipping through a porous border with President Obama unwilling to do anything about it.  Calls are being made for a bigger, taller, and longer wall, more aggressive policing of the border, and the forced deportation of those who are already living here.  These calls have been a centerpiece of Donald Trump’s campaign from the day he announced his candidacy (when he asserted Mexico is “sending” criminals, drug pushers, and rapists to the US).  More recently, in the November 10 Republican presidential debate and in more detail in the days after, Trump called for the creation of a new special police force, a “massive deportation force”, which would aggressively pursue and deport those in the US who were believed to be illegal. Yet Trump has for some time now been at the top of polls of Republicans as their choice for president.

But what are the facts?  The US is actually not being flooded by illegal immigrants from Mexico. Nor has the supposed “problem” become far worse under President Obama.  The Pew Research Center released on November 19 a report with careful estimates of the number of unauthorized immigrants from Mexico residing in the US.  The report brings up to date figures the Pew Center had released previously for earlier years.

The chart at the top of this post is a replication of the chart presented as Figure 5 in Chapter 1 of their report, with figures on the estimated total number of unauthorized Mexican immigrants resident in the US by year.  The second chart is then simply the net annual flows as calculated from the numbers on the totals in the first chart (the change from one year to the next).  It should be noted that Pew Center presented estimates only for 1995, 2000, and 2005, before going to annual figures.  Hence the figures on net flows for 1996 to 2000 and 2001 to 2005 assume equal annual changes.

The Pew Center estimates that the number of unauthorized Mexican immigrants resident in the US reached a peak in 2007, and has since fallen substantially.  The falls in 2008 and 2009 can probably be attributed mostly to the severe downturn in the US in those years, when jobs were scarce and more Mexicans immigrants chose to return to Mexico than come to the US.  However, it is significant that as the US labor market has strengthened since 2009, with the unemployment rate hitting just 5.0% recently, the net outflow of Mexican immigrants continued.  In each and every year of the Obama administration there has either been a net outflow, or no net change, in the number of unauthorized Mexican immigrants in the US.

There are many reasons for this, including stepped up and more effective border enforcement as well as more deportations.  The Pew Report provides a good review of the factors, and I will not go into them all.  But one fact to note is that in FY2013, with Obama as president, the number of deportations reached a record high of 315,000, an increase of 86% from the level in 2005.

One may debate what the appropriate policy should be.  In my view, while immigration has been controversial throughout US history, the US has always also always benefited from it. Recall the discrimination against Catholic immigrants from Ireland in the early and mid-1800s, and yet how such immigration developed into an important part of what made the US what it is now.  There is little reason to believe that this time is different.

But regardless of whatever one’s policy views are, one should start with the facts.  And it is clear that the Republican candidates for president do not have these straight.