The Obama budget’s misguidedly lower revenue target

President Barack Obama’s fiscal year 2014 budget request, released Wednesday, is a more centrist blueprint than his fiscal 2013 request—which was the most progressive and ambitious with regards to job creation and taxation to date. As I argued in a U.S. News debate club series, the contrast is most conspicuous and consequential on three fronts: proposing less ambitious revenue targets, largely abandoning the American Jobs Acts, and identifying benefit cuts (not just efficiency savings) in social insurance programs that the president would exchange for the more modest revenue increases.

Of these, the pre-compromise on Republicans’ third rail—raising new revenue—is perhaps the most perplexing, because unlike scaling back stimulus or cutting Social Security benefits it works directly against the administration’s prioritization of deficit reduction (a priority regrettably at odds with ensuring faster economic recovery). Remember that the “ten dollars in spending cuts for a dollar in revenue” formulation—an empirical policy slam-dunk for the GOP and twice as conservative as the five-to-one ratio for deficit-reduction measures enacted in the 112th Congress—was heretical during the GOP presidential primary campaign. The political hurdle on taxes is getting Republicans to accept the first penny of revenue and buck Grover Norquist’s Taxpayer Protection Pledge. Given this, scaling back revenue proposals accomplishes nothing.

At first blush, the president’s budget doesn’t appear to have given away much on the revenue front. The OMB Summary tables show revenue averaging 19.1 percent of GDP over FY2014-2023, seemingly roughly in line with revenues at 19.2 percent of GDP over FY2013-2022 in his previous budget request (and revised to 19.1 percent in the Mid-Session Review). But it’s important to dig deeper and figure out what’s going on here.

Revenue level comparisons between budget proposals must account for shifting the budget window back a year. In the near-term, projected revenue levels will bounce back as a share of GDP with (routinely overly optimistic) projections of the economy recovering. But even at full employment, revenue will gradually rise as a share of GDP; as incomes (especially those of high earners) rise faster than inflation—the parameters of the income tax and alternative minimum tax, among others, are indexed to the consumer price index (CPI)—more taxable income shifts into higher tax brackets, what economists refer to as “bracket creep.”

But something else is at play distorting comparisons between budgets: out-year revenue levels are increasingly propped up by the Affordable Care Act’s (ACA) excise tax on so-called “Cadillac” insurance plans, slated to take effect in 2018. The parameters of the excise tax are indexed to CPI + 1 percentage point. But because health care costs and insurance premiums have risen much faster than inflation, this indexation will fall well shy of health insurance premium inflation, meaning that a rapidly rising share of health insurance premiums will be subject to the tax.1 Consequently, the excise tax is a money machine because of bracket creep on steroids—one of the factors contributing to a dramatic downward revision to public debt projections in the Congressional budget Office’s (CBO) extended current law long-term budget outlook between 2009 and 2010 (-195 percentage points of GDP in 2083). But projected revenue increases from a tax that has yet to take effect should not be used to subsidize less revenue elsewhere.

Consequently, the more informative comparison looks at revenue levels over FY2013-2022; shifting back the budget window just one year drops total revenue in the president’s budget to average 18.9 percent of GDP. My preferred comparison with the president’s fiscal 2013 budget is the CBO’s re-estimate of the president’s budget, adjusted for subsequent economic and technical revisions to revenue projections, which shows revenue averaging 19.3 percent of GDP over FY2013-2022 (down from 19.4 percent in their original March 2012 projections). Relative to this baseline, the president’s fiscal 2014 budget would collect $541 billion less over the same decade.

Much of the revenue loss relative to last year’s budget proposal is attributable to the American Taxpayer Relief Act (ATRA), better known as the lame-duck budget deal. Prior to the ATRA, ending the Bush-era income tax cuts above the Obama administration’s definition of upper-income households would have raised $823 billion over FY2013-2022. Instead of raising the top two income tax rates from 33 percent and 35 percent, ATRA added a top 39.6 percent rate at a higher income threshold, leaving a narrow 35 percent bracket as well as an untouched 33 percent bracket. Additionally, the personal exemption phase-out (PEP) and limitation on itemized deductions (Pease) were reinstated, but also at higher income levels than the Obama administration had proposed in their first four budgets. Consequently, the ATRA raised only $598 billion from raising tax rates and reinstating PEP and Pease, relative to full extension of the Bush-era tax cuts.

The budget again proposes limiting the value of numerous tax preferences for upper-income households to 28 percent, down from a filers’ top marginal tax rate; but this limit on tax expenditures raises less revenue than last year’s request because of interactions with the new ATRA tax rate structure, which is flatter further up the income distribution. The limitation would raise $455 billion over FY2013-2022, down from $574 billion over this period in the fiscal 2013 budget request.2 Consequently, the president’s fiscal 2014 budget collects roughly $344 billion less from these proposals over FY2013-2022, or $309 billion less accounting for a one-year implementation delay of the 28 percent limitation.

The budget also dedicates revenue policy savings of $335 billion—mostly from international tax system reforms and business tax preferences, such as repealing fossil fuel preferences and last-in, first-out inventory accounting rules—to lowering the corporate tax rate. Net of $241 billion of new or extended tax preferences, such as extending the research and experimentation credit and increased expensing for small businesses, this would result in $95 billion of revenue diverted to reducing the top tax rate.

There are some sensible revenue increases—notably an increase in tobacco excise taxes that would raise $78 billion to fund early childhood education investments and a millionaire’s minimum tax that serves as a floor to the tax preferences afforded to capital income, better known as the “Buffett Rule.”

The other major departure from last year’s budget is the proposed change of tax code parameters’ indexation using a slower-growing “chained” price index, which will increase revenue by spurring more bracket creep. But this change also involves switching to the slower-rising “Chained CPI” for Social Security cost of living adjustments—which is not a technical improvement, but merely a poorly designed (and poorly rationalized) benefit cut.

If this switch to a chained price index is supposed to represent compromise with the GOP, it’s worth noting that supply-side high priest and GOP tax enforcer Grover Norquist declared that adopting Chained CPI for tax parameter indexation would be a violation of his Taxpayer Protection Pledge.

Bottom line: any apples-to-apples comparison with the fiscal 2013 budget reflects a substantially lower revenue target in the president’s fiscal 2014 budget. Abandoning sensible tax reforms worsens the deficit and impedes restoring revenue adequacy without teasing Republicans any closer to that first penny in revenue and bucking Mr. Norquist’s pledge. That less ambitious revenue targets are coupled with Social Security benefit cuts, deeper discretionary spending cuts, and less fiscal support is all the more troubling.

This political gambit may yet put the squeeze on Republicans to replace sequestration with more sensible deficit reduction, but it’s looking an awful lot more like a botched sac than a skewer.

1. Equivalently, the excise tax may induce workers to keep premiums low by accepting less-generous health plans. This should over time lead to higher wages compensating for lower employer-paid premiums and higher tax collections on wage incomes.

2. A small portion of this $118 billion decrease is attributable to delaying implementation one year. Cumulative revenue from the 28 percent limitation fell 14.6 percent over FY2015-2022 (years unaffected by implementation concerns); applied to FY2013-2014 receipts from the FY2013 budget requests would imply $35 billion of revenue loss from delaying implementation.