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Some quick preliminary thoughts on President Obama's federal budget

1) Changing the official baseline to include the costs of patching the AMT and funding the Iraq and Afghanistan wars greatly increases the honesty and transparency of the document. As time goes on, it?s going to be interesting to try to give fair credit while also noting the inevitable instances in which there is still less than 100% straightforwardness and candor. GW B*sh ? I don?t think I should print in full here ugly 4-letter curse words ? set the bar for honesty so low ? 20 feet underground or so ? that it?s hard to get back to normal evaluation. And I feel it?s the job of someone like me to hold the new Administration?s feet to the fire a bit, and demand more than one could really politically expect. But they should also be credited for the dramatic change in norm.

2) It?s true that putting the above things into the baseline means one doesn?t have to pay for them in order to maintain the acknowledged baseline. But that perhaps would set the bar a little too high at this early stage.

3) While there are serious empirical questions about the revenue to efficiency payoff from raising top marginal rates, my own judgment is to be fine with going back to 39.6%. Reducing the tax benefit from top-bracket itemized deductions is a step in the right direction as well.

4) The Making Work Pay credit in the current stimulus package reaches too high in the income range to be effective stimulus ? it would be much more cost-effective if cut off sooner. Its permanent retention in the budget raises different sorts of issues. Essentially, it lowers marginal tax rates (MTRs) in the lower brackets by a more convoluted mechanism than simply cutting down the Social Security payroll tax. Budgetary accounting in the Social Security Trust Fund is the reason for the indirect methodology. Despite the Making Work Pay credit?s name, I think of its rationale as stronger in distributional than efficiency terms (i.e., it benefits recipients more than it improves overall work incentives since it will often be inframarginal).

5) Turning to the items listed as loophole closers:

--I?m certainly fine with the carried interest change, much discussed in this blog and elsewhere a couple of summers ago, but the devil is in the details ? it could easily be (mis-)drafted to accomplish nothing. Senator Schumer a couple of years ago proposed applying the change more broadly than just to hedge funds and the like ? e.g., to real estate and oil and gas partnerships. Viewed by many at the time as a deliberate poison pill, this was also clearly a desirable change in the proposal if actually adoptable. I don?t know yet how broadly the Administration is proposing to implement the change.

--Eliminating various oil and gas company preferences also is all to the good. An amusing bit of history for me is the proposal to raise two to six million dollars per year, starting in 2011, by eliminating the oil and gas ?working interest? exception to the passive loss rules. I was working on the Joint Committee of Taxation staff in 1986 when this exception was added to the Senate Finance Committee tax reform bill. Trivial though it was, we were told that failing to adopt it would change the committee vote on fundamental tax reform from 20-0 in favor ? all to the tune of speeches about how this was the greatest tax bill in history ? to at least 11-9 against. I?m almost reminded of the old joke about academics, saying that the fights are so bitter because the stakes are so low.

--Repealing LIFO inventory accounting is probably a good thing as well, despite the view that LIFO provides indirect partial inflation indexing.

--Codifying the economic substance doctrine gets a revenue estimate (rising swiftly to almost a billion dollars in 2019) that seems to be a bit high, given that I regard the change as almost a ceasefire in place, apart from its (a) preventing courts from saying there is no such doctrine and (b) tilting the scales a bit towards a tougher rather than a looser interpretation of the doctrine. I believe past revenue estimates were even higher, however.

--?Implement international enforcement, reform deferral, and other tax reform policies? gets scored at $70 billion for the next 5 years and $140 billion for the five years after that. Sounds a bit ambitious. Most academics in the international tax policy area, including me, are skeptical about both the merits and the feasibility of attempting significantly to increase the taxes paid by U.S. multinationals on investment abroad. Corporate residence (since the outbound taxes only apply to what are treated as U.S. resident corporations) is too weak a reed to bear so heavy a weight. This one bears close watching as the details emerge.

--Extend low tax rates for dividends and capital gains, but put them at 20 percent rather than 15 percent. This is about where I would go as well. As per my book,, while there?s little rationale for the corporate double tax, and in particular for taxing dividends (other than as a backstop to the corporate level tax), it?s probably better to focus any tax reduction on the entity rather than the shareholder level. Capital gains are one case where Laffer curve considerations actually do emerge within the politically and administratively feasible set of tax rates. 20 percent is still well below the revenue maximizing rate (and one would want to be below that). They score this as a revenue loss because the baseline is expiration of the Bush tax cuts, but presumably the change from 15 to 20 percent raises non-trivial revenue.

Full post as published by Start Making Sense on February 27, 2009 (boomark / email).