Summary

Under current state law, family farms are exempt from paying certain property taxes on a wide range of farm equipment such as tractors, combines, balers, sprayers, and more and farm products such as livestock and crops.  Georgia’s 2022 farm tax exemption measure would expand those tax exemptions to dairy products and eggs. The measure would also allow larger farms that are created by merging two or more family farms to qualify for tax exemptions.  Equipment must be used for farm production and be owned or held under a lease-purchase agreement to qualify for the tax exemptions, and it does not apply to automobiles and trucks.

Fiscal Impact

Georgia’s poultry industry generates $1.3 billion in tax revenue annually.  Information for dairy products and eggs, unfortunately, was not available.  According to a representative of the Georgia Milk Producers, the industry’s impact, economically, on the state is estimated at $1.03 billion for the 2021 calendar year, some portion of which is tax revenue. Complete analysis of how this measure would impact Georgia taxpayers was not available.

Proponents’ Arguments

Georgia Gov. Brian Kemp supports the measure. He stated, “There’s no more generational business than a family farm…I know how important small business is to Georgia’s economy, and that’s what Georgia Farm Bureau and the Georgia Agribusiness Council are fighting for in the Capitol every day.” 

The agriculture industry also supports the measure because it would provide their businesses with a considerable tax break.

Opponents‘ Arguments

While there is no active organized campaign against this measure, some members of the legislature expressed concerns about giving a selected group a special tax break that other groups do not get.

Discussion

This tax measure is an initiative promoted by Georgia Gov. Brian Kemp and is consistent with his efforts to provide tax relief and other favorable policies for the state’s agricultural sector. Support for the agricultural industry, however, extends far beyond just the governor.  Because most of the state’s lawmakers, especially in the Republican Party, also represent constituencies in the rural parts of the state, tax breaks for the agricultural and timber industry have been politically popular.

This measure is very similar to one passed in 2000 that gave a tax exemption for certain farm equipment of family-owned farms for tools and trade implements of manual laborers.  In 2006, voters also approved a measure expanding the homestead exemptions and property tax exemptions for agricultural products.

However, a key principle of good tax policy is that taxes should not pick winners. Broad-based tax cuts are always better than narrowly targeted ones that only benefit a select, politically-connected, or popular group. This measure is not a broad-based tax cut. At best, it would expand an existing tax break the agricultural industry already gets to apply more broadly across that industry.

Tax breaks for selected industries are not without consequences.  They are not necessarily accompanied by state or local government spending cuts to offset any lost revenue, so the tax burden often shifts to taxpayers or industries that are not as favored by politicians.

The post Georgia ballot measure to expand tax exemptions for family-owned farms (2022) appeared first on Reason Foundation.

The Georgia Timber Equipment Exempt from Property Taxes Measure on the November 2022 ballot would change the state’s tax law so that starting Jan. 1, 2023, all timber equipment such as feller bunchers, forwarders, harvesters, chainsaws, skidders, saws, stump grinders, log loaders, and bandsaws would be exempt from ad valorem taxes.  However, this exemption would not include timber itself. 

Fiscal Impact

Data shows the timber industry paid nearly $20 million in ad valorem taxes to the state in 2020. However, the state does not show what percentage of that revenue is derived from timber equipment so it is unknown how this would impact state and local government tax revenues.

Proponents’ Arguments

Georgia Gov. Brian Kemp supports the measure, and has argued the measure will “help us treat the forestry industry the same way that we do agriculture as well as protect hunting, fishing, and conservation land, and more.”

The timber industry also supports the measure. Tobey McDowell of C. McDowell Logging claimed, “It takes 8-10 pieces of equipment, including the trucks and trailers, for us to run just one logging crew, and the overall costs for that equipment is increasing every day. So, when you consider the tax bill on our equipment, it determines whether we purchase new equipment, keep running old equipment, or just give up all together. So, right now any break we can get will help.”

Opponents’ Arguments

There is no organized campaign against this measure. State Sen. Lindsey Tippins (R-Cobb County) voted against the measure when it was before the state legislature and told us in a phone interview that he opposes it based upon the potential unfairness of the timber industry being exempt from ad valorem taxes while other industries, such as the construction industry, and many others, still have to pay those taxes.

Discussion

This tax measure is another initiative in Georgia Gov. Brian Kemp’s consistent efforts to provide tax relief for the state’s agricultural sector.  Most of Georiga’s state lawmakers, especially in the Republican Party, also represent constituencies in the rural parts of the state where tax breaks for the agricultural and timber industries have been politically popular. This measure is very similar to one passed in 2000 that gave tax exemption for certain farm equipment of family-owned farms for tools and trade implements of manual laborers.  In 2006, voters approved an additional measure expanding the homestead exemptions and property tax exemptions for agricultural products.

However, a key principle of good tax policy is that taxes should not pick winners. Broad-based tax cuts are always better than narrowly targeted ones that only benefit a select, politically-connected, or popular group. This measure is not a broad-based tax cut. At best, it would expand an existing tax break the agricultural industry already gets to apply more broadly across that industry.

Tax breaks for selected industries are not without consequences.  They are not necessarily accompanied by state or local government spending cuts to offset any lost revenue, so the tax burden often shifts to taxpayers or industries that are not as favored by politicians.

The post Georgia measure to make timber equipment exempt from property taxes (2022) appeared first on Reason Foundation.

Summary

This property tax amendment would change the Georgia constitution to allow local governments to grant temporary property tax changes for properties damaged by disaster events and located within disaster areas. Some details of the tax relief mechanism and rules governing local government use of this power will likely need to be legislated.

State Rep. Lynn Smith (R) sponsored the constitutional amendment after an EF-4 tornado—the Enhanced Fujita Scale ranks tornados from zero to five, with five being the most devastating—hit Coweta County in the southwestern exurbs of Atlanta in March 2021. The Federal Emergency Management Agency (FEMA) rejected individual disaster assistance, however. In July 2021, the Atlanta Journal-Constitution reported:

In a letter this week to Gov. Brian Kemp, the Federal Emergency Management Agency wrote “the impact to the individuals and households from this event was not of the severity and magnitude to warrant the designation of the Individual Assistance program.” Such assistance includes financial aid and services for people with uninsured expenses…In May, President Joe Biden declared a disaster in Georgia, making federal funding available for state and local government recovery efforts in Coweta and other counties. But many residents with uninsured property losses are still struggling in the wake of the storm, Newnan Mayor Keith Brady said.

…FEMA issued a prepared statement Friday, saying Kemp appealed its “original denial of Individual Assistance and FEMA found that its original evaluation was correct.”

“The biggest factor when determining the need for either public or individual assistance is whether the state and local jurisdictions have the resources available to meet the recovery needs,” the agency said.

In addition to the federal government’s decision not to provide federal taxpayer-funded assistance, state law prevented any type of tax breaks for property damaged by natural disasters. Therefore, Coweta County homeowners had to pay property taxes on 1,726 homes that were destroyed or damaged.

Rep. Smith said officials in the city of Newnan “wanted to be able to give some tax relief in 2021” but were not able to do so. The amendment was passed unanimously by both chambers of the Georgia State Legislature.

Fiscal Impact

The average Georgia property tax bill is $1,771 per year. If this figure is applied to all 1,726 homes devastated by the 2021 tornado to give an estimate, exempting those families from paying taxes would reduce total property tax revenue by $3.1 million annually. 

However, the amendment would not apply just to the Coweta County homes. All property in Georgia that is affected by various natural disasters could be exempted from property taxes, which would increase the fiscal impact. For example, if three percent of properties qualified for exemptions in a year, that would total $204 million per year. 

Proponents’ Arguments For

Proponents wanted federal taxpayers to aid the tornado victims. “It still breaks my heart that federal funding was denied for individuals, but HR 594 would allow local governments to step in and provide an alternative pathway to direct relief for citizens in the future, especially if the federal government in Washington fails to do so,” State Rep. Lynn Smith (R) stated.

She added that the amendment “provides this option to communities who may face the same devastation that Coweta County did last year.”

Opponents’ Arguments Against

There were no arguments against the bill. No members voted against the bill. However, 29 members of the Georgia House of Representatives and one state senator abstained. Further, there were no Democratic cosponsors, potentially indicating limited support from Democrats. 

Additional Discussion

When a property is damaged due to a natural disaster, FEMA determines whether state and local governments have the resources to provide sufficient aid. The largest factor in FEMA approving or denying aid to homeowners is if a county and/or city government have the resources to provide their own financial aid. Local officials In Coweta County and the city of Newnan wanted to waive the collection of property taxes, but state law prevented the county and city from taking those actions. As a result, Rep. Smith sponsored an amendment to allow counties to waive the collection of property taxes from those homeowners whose property is uninhabitable.

On one hand, the legislation provides important relief to homeowners. It does not require local governments to provide funding. Rather, it allows governments to waive the collection of property taxes.

If the federal government does not provide resources, state and/or local governments can provide direct financial resources, waive property taxes, both, or neither.

However, this amendment also creates three policy challenges, each relating to wealth transfers. First, many homeowners in Coweta County were underinsured or uninsured. This property tax relief bails them out. And in the future, it incentivizes homeowners to underinsure their own properties because they may expect other taxpayers to foot the bill.

Second, the tax exemption could lead to a major loss in revenue for counties. Georgia has 159 counties and thousands of cities. If fires, flooding, hail storms, tornados, and other issues can prompt property tax exemptions, it is easy to see the number of exemptions growing exponentially in the years to come. And, even if only 3% of homes had property taxes waived in a given year, the statewide loss would be more than $200 million. Counties are likely to try to offset those losses by imposing higher property taxes on other homeowners or new taxes or fees.

Finally, the tax exemption allows FEMA’s outdated, 20th-century approach to disbursing disaster aid to continue. Currently, FEMA justifies whether to provide federal aid based on the average income and wealth of a region. Yes, many of the homeowners in Coweta County lived in mobile homes and were below the average federal income, but FEMA ruled the local and state governments had the funding to assist them rather than asking federal taxpayers to do so. Going forward, FEMA could improve by determining this type of federal aid based on census block grants, a more detailed geographic unit.

The post Georgia temporary property tax change for disaster areas amendment (2022) appeared first on Reason Foundation.

Unfortunately, this policy path is reducing the value of Americans’ paychecks and savings accounts as devaluation is used to effectively default on obligations incurred over decades. While it is clear how decades of deficit spending, rising entitlement costs, off-the-books war spending, and massive stimulus packages got America into this situation, a new data project from Reason Foundation reveals the true depths of this debt crisis.

The Debtor Nation visualization traces the growth of federal spending back to 1965, when Congress passed Medicare and Medicaid, helping fuel the explosion in health care costs thereby contributing significantly to the current $30 trillion national debt. From the creation of those entitlement programs the federal government ran an annual budget deficit in 52 of the 57 years between 1965 and 2022.

But beyond the debt figure typically used, Reason Foundation’s analysis of the latest federal financial report published by the U.S. Department of the Treasury in February finds that federal liabilities, when including obligations from entitlement programs, exceed $100 trillion. Unfunded future Medicare obligations account for almost 47 percent of that total.

The official federal balance sheet excludes Social Security and Medicare obligations, even though these benefits — accrued and anticipated by American workers not employed by the federal government — have similar legal status to the retirement benefits accrued and expected by federal civilian employees and veterans. Proper accrual accounting, which is the approach used both by corporations and state governments, requires liabilities to be recognized when they are assumed. The federal government took on obligations for Social Security in 1935 and Medicare in 1965, so it is past time to recognize these liabilities when reporting the national debt.

To its credit, the U.S. Treasury provides these ‘off balance sheet’ liabilities in a separate Statement of Social Insurance. Placing these liabilities on the federal balance sheet where they belong yields a total debt burden of $103 trillion as of the end of the 2021 fiscal year, which was 446 percent of America’s gross domestic product (GDP).

Much of this debt is now coming due as a large cohort of Baby Boomers retire and become eligible for Social Security and Medicare benefits. Baby Boomers began reaching early retirement age in 2008, and the last Boomer will reach full retirement age in 2031. In the 2030s and ‘40s, the annual trillion-dollar budget deficits needed to pay for these benefits will take America’s debt and deficits to largely uncharted territory.

The Congressional Budget Office’s own projections show that just making interest payments on the 2051 federal debt will exceed all the federal government’s tax revenues by 46 percent, crowding out discretionary spending. Those projections are highly sensitive to the future path of interest rates, a factor partially controlled by the Federal Reserve as recent interest rate hikes have illustrated.

The Federal Reserve holds down federal borrowing costs by purchasing more federal debt securities, typically with newly created reserves. By competing with other buyers of U.S. Treasury securities, it can push down interest rates. The Federal Reserve typically remits most of the interest income it receives on its bonds back to the U.S. Treasury, further lowering the government’s effective borrowing costs. There’s a possibility that the Fed may need to step in more and more in the future if foreign demand for U.S. debt securities decreases.

The two biggest foreign buyers of U.S. Treasury securities are China and Japan. China’s holdings of U.S. debt have declined $1.25 trillion in 2015 to $1.07 trillion in 2021 amidst deteriorating relations. In the worst-case scenario for the U.S., Chinese bondholders may need to liquidate more while dealing with fallout from their lockdowns and the collapse in domestic home prices while Japan’s holdings could stop growing or even shrink as that country grapples with economic issues related to its own aging population’s decline.

In that case, to hold down federal borrowing costs and interest rates, the Federal Reserve would seek to buy more U.S. Treasury securities, pumping more money into the economy, risking more inflation and elevating prices. This would devalue the existing debt and hold down the debt-to-GDP ratio while causing pain for Americans relying on a nest egg of dollar-denominated assets or receiving fixed-income payments. Cost-of-living increases may protect Social Security recipients from the worst ravages of inflation, but they would further drive up federal spending and deficits and increase calls for the Fed to print more money, which would trap Americans in this inflationary loop.

The massive federal debt accumulation is going to force extremely tough political and policy choices in the coming decades, but political leaders should stop the bleeding and start to contain the damage by adopting a more prudent approach to federal spending.

The federal budget process should be overhauled so that all forms of federal spending, including entitlements, are included in the budget process. Federal budgeting should rely on the accrual basis of accounting, forcing elected officials to internalize the long-term impact of entitlement programs and spending proposals. The size of annual deficits should be strictly capped. Given the looming debt and interest payment problems, if the budget can’t be balanced in the short-term, the deficits should be capped to prevent the growth of the debt-to-GDP ratio.

Since 1965, Congress has pushed tens of trillions of debt onto future generations. The subsidization of Baby Boomers is going to cripple young people and the country if political leaders don’t start to confront these long-term fiscal issues.

A version of this column previously appeared in the Hill.

The post The true depths of the U.S. debt crisis appeared first on Reason Foundation.

In November 2016, California voters approved Proposition 64 to enact a regulated, adult-use cannabis market in the Golden State. At the time, four other states had already created adult-use cannabis markets, including Alaska, Colorado, Oregon, and Washington.

California already had a largely unregulated medical cannabis market in place, following voters’ historic passage of Proposition 215 in 1996, which was the first medical marijuana law in the nation to go into effect. Since Proposition 64 required specific regulations to govern inventory tracking, licensing, testing and more, these regulatory provisions would have to extend to the unregulated legacy medical market. If not, market participants could subvert the regulatory intent contained in Proposition 64 simply by remaining in the unregulated medical market

Realizing this need, California lawmakers passed the Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA) in 2017.

MAUCRSA superseded prior legislation from 2015 called the Medical Cannabis Regulation and Safety Act, which sought to create a regulatory structure for the medical market but never took effect due to the passage of Proposition 64 and MAUCRSA, which largely built on the regulatory approach that had been developed within that prior legislation, but also extended it to the newly authorized adult-use market.

The statutory language contained in Proposition 64 and MAUCRSA combine to create the legal framework for California’s commercial cannabis industry. Regulations governing the industry must be consistent with these authorizing statutes. Proposition 64 contained important provisions that strongly affect California’s commercial cannabis market that cannot be changed through regulatory action alone. Chiefly, these include imposing two new excise taxes and devolving authority to local governments to regulate or outright ban certain or all types of commercial cannabis activity within their jurisdictions.

Taxes affect both consumers’ and producers’ decisions in the legal market primarily by introducing a price disparity between legal cannabis products and comparable cannabis products offered through the illicit market. Similarly, local bans on legal sales over extended geographic areas can drive consumers without access to legal products within a reasonable distance of their homes to purchase substitute goods on the illicit market.

This analysis develops an empirical model to estimate the degree to which California’s tax regime affects participation within its commercial cannabis market, and how participation may change through different approaches to taxation.

Part 2 of the study details the various tax structures currently facing legal cannabis enterprises in California and how those tax structures have performed in yielding public revenue.

Part 3 examines the key factors that influence consumer decisions to participate in the legal or illegal market.

Part 4 reviews the existing literature on consumer price sensitivity for cannabis products and calculates a price sensitivity for consumers of legal products in California and Oregon.

Part 5 uses data calculated in prior sections to model California consumers’ expected behavior due to changes in retail price in response to a change in tax policy.

Finally, Part 6 of the report concludes with recommendations for improving the performance of California’s legal cannabis market.

Full Policy Study: The Impact of California Cannabis Taxes on Participation Within the Legal Market

The post The impact of California’s cannabis taxes on participation within the legal market appeared first on Reason Foundation.

Tardy federal budgets are nothing new in Washington. According to the Tax Policy Center, Congress has only completed the budgetary process in a timely fashion, which requires passing all 12 appropriations bills prior to October 1, four times since fiscal year (FY) 1977. The last time Congress’ budgetary process worked as expected was FY 1997, more than two decades ago.

When the budget does not pass on time, Congress must pass a continuing resolution (CR) to avoid a government shutdown. Since continuing resolutions typically maintain departmental funding at prior-year levels, they do not signal the policy choices ultimately made in the budget process. As a result, federal managers must begin the fiscal year without a clear direction as to whether they should be increasing or decreasing staff and non-employee operational expenditures. If a federal agency or department ultimately receives a significant funding increase or funding cut in the final appropriations bill, managers may have insufficient time to respond efficiently.

While federal budgeting has been broken for some time, the situation in 2022 is especially bad. Over five months into the budgetary year, the House Rules Committee produced a 2,741-page omnibus budget bill in the wee hours of March 9, just hours before the bill’s scheduled vote on the House floor.

At the last minute, lawmakers found what some considered to be a poison pill embedded in the omnibus. To fund a supplemental COVID-19 expenditure, the omnibus clawed back money provided to states in the American Rescue Plan Act of 2021. However, the claw-back was inequitable.

Under ARPA, 20 states received their full aid allocation last year, while another 30 states received half their allocation in 2021 with the rest of the money slated to arrive later this year. The rescission only affected this latter group of states by reducing their second ARPA check.

States receiving a split allocation were those that suffered an increase in their unemployment rates of less than two percentage points during the first year of the COVID-19 pandemic. That universe included some purple and conservative states, such as Florida, Georgia, Alabama, and Utah, which tended to have fewer shelter-in-place and other restrictions in the pandemic.

Given that Florida was already slated to receive the smallest amount of ARPA state and local aid on a per capita basis, singling it out for this rescission seemed unfair to many. California, by contrast, would not have faced a claw-back of the ARPA money even though it recently reported a $75 billion budget surplus.

Eventually, the COVID-19 spending was removed from the package before the omnibus was easily approved in the House and then in the Senate in a bipartisan, 68-31, vote. The ultimate omnibus bill included many earmarks as part of the backroom horse-trading that led to a bloated, “must-pass” bill that will lead to a larger national debt.

The Congressional Budget Office’s last projection of FY 2022 discretionary budget authority was $1.4 trillion. The omnibus ultimately provided a discretionary budget of $1.5 trillion. (Budgetary authority and outlays are not the same but tend to move together.) The ultimate difference, about $35 billion of additional budgetary authority, is likely to increase the deficit in FY 2022. It also sets a higher spending baseline in future years.

As a result, the omnibus bill is likely to add hundreds of billions to the deficit over CBO’s 10-year projection window. The $13.6 billion Ukraine aid package in the bill is also unfunded, and will thus be tacked onto the deficit, but at least it is not a recurring expense (for now).

In the rush to pass the continuing resolution, its long-term deficit implications have received relatively little attention. And this raises another problem with today’s budgetary process or lack thereof. Budgeting is supposed to be a process of allocating scarce resources. This scarcity is typically imposed through a clearly defined limit.

In most state governments, for example, a balanced budget requirement limits spending to the amount of revenue anticipated in any given fiscal year. Having given up on balanced budgets long ago, however, Congress has no clear spending limit. As a result, there is no procedural bulwark against what happened in the current budget cycle. Republicans wanted more defense spending, Democrats wanted more non-defense spending, and they compromised by including both without offsets. Politico noted:

Leaders in both parties have declared the legislation a win. Democrats boast of the almost 7 percent increase they secured for non-defense agencies, increasing that funding to $730 billion. Top Republicans tout the $782 billion they locked in for national defense, a 6 percent hike from current spending.

Looking ahead, it is worth noting that prospects for the FY 2023 budget process already look dim. The process is supposed to kick off with the submission of the president’s budget, required by law to be submitted by Feb. 15, which has yet to happen this year. Once congressional committees start working on the 2023 budget, members will likely be focused on their re-election campaigns, slowing any progress. Sadly, perhaps the best outcome we can expect for the coming fiscal year is a two-month continuing resolution followed by an omnibus budget bill during the lame-duck session after November’s congressional elections.

With the last major federal budget reform now 50 years behind us, and after 20 consecutive years of federal budget deficits, the congressional budget process obviously needs an overhaul. The key elements of any budget reform should be focused on a fixed and realistic timetable for budget consideration and adoption, as well as a clearly defined limit on spending.

The timing issue could be addressed by moving to a biennial budgeting process, which is used in many states, or even a quadrennial timetable coinciding with a presidential term. Enforcement mechanisms might include withholding of Congressional and staff salaries and funding for their offices and travel if the budget is not completed and signed on schedule.

Balanced budgets no longer attract much support from either major political party and no longer seem feasible in the current context of Social Security and Medicare expanding to accommodate Baby Boomer retirements. But, even if lawmakers don’t want to tackle the runaway costs of entitlement programs, federal spending can be limited without requiring that it be equal to revenue.

One alternative to the current process: Limit federal spending to a level at which it does not increase the nation’s debt-to-gross domestic product (GDP) ratio.

It is notable that the shambolic budgets of FY 2022 and FY 2023 are happening under a unified government, just as when Republicans had complete control in the first years of the Trump administration. The hope has to be that, eventually, leaders on both sides of the aisle concerned with government effectiveness can coalesce around meaningful budget reforms, including those covered here.

The post The broken federal budget process gets even worse with $1.5 trillion omnibus spending bill appeared first on Reason Foundation.

Rate hikes will drive up federal debt service costs.

In July, the Congressional Budget Office (CBO) projected that the federal government would spend $306 million on $24.4 billion of publicly held debt, implying an average interest rate of about 1.25 percent. With such a large volume of debt outstanding, the U.S.’s annual interest costs could increase rapidly if interest rates rise.

But there are a couple of caveats.

First, some federal debt is long-term and thus its interest rates are locked in. Also, now that the Fed has bought up a large fraction of outstanding Treasury securities, much of the government’s extra interest costs are returned to the Treasury when it remits its net income to the federal government each year.

Higher interest rates also pose threats to the value of investment assets. Stock prices could fall as investors switch to fixed-income securities providing better returns. But as long as real interest rates — i.e. the difference between interest rates and inflation — are negative, most investors could be expected to stick with stocks. Home price appreciation might also weaken because higher mortgage interest rates reduce housing affordability: Buyers will have to take out smaller loans to make their target monthly mortgage payment.

But the biggest fiscal risk may stem from corporate lending. Rather than issue fixed-rate bonds, many highly leveraged companies rely on the syndicated bank loan market where most borrowing takes place on a floating rate basis. According to research from Fitch Ratings, $1.6 trillion of syndicated loans are currently outstanding with almost all borrowers carrying either speculative grade credit ratings or the lowest investment grade rating (Baa3 on Moody’s scale or BBB- from S&P, Fitch and other agencies).

Syndicated loans are distributed across multiple banks with about half of the volume packaged into Collateralized Loan Obligations (CLOs). Although analogous to the subprime Residential Mortgage-Backed Securities (RMBS) that triggered the Great Recession, CLOs have generally performed well over their 30-year history.

The loans packaged into subprime RMBS and CLO deals have high default risk, but corporate borrowers have generally proven more reliable than homebuyers with low credit scores. That may change when the Fed starts raising interest rates, especially if the hikes are precipitous.

A wave of leveraged loan defaults could harm both CLO investors and banks — to the extent that they continue to hold syndicated loans on their books. Because CLOs are well diversified, it is unlikely that defaults will impact investors in the senior AAA/Aaa rated tranches.

But if a lot of leveraged corporate borrowers are forced into bankruptcy by higher interest costs, we could see waves of layoffs. Suppliers to failing companies may also face late and/or partial payments, spreading the pain around the economy.

In this way, a sharp increase in interest rates could significantly slow economic growth or even trigger a recession.

Corporate defaults played a significant role in the 2001-2002 recession, even though the blame is more commonly put on the collapse of the dot-com stock bubble and the impact of the 9/11 terror attacks. But around the time of this recession, such big names as United Airlines, Kmart, Global Crossing, WorldCom, and Enron filed Chapter 11 bankruptcy petitions.

Congress could reduce the pressure on the Fed to raise interest rates by reining in deficits. Lower deficits would mean a reduced volume of Treasury securities coming onto the market, which push up interest rates, unless purchased by the Fed with new money. Although meaningful spending cuts seem unlikely in the current Congress, it could help by not passing the Build Back Better act — something Sen. Joe Manchin (D-W.Va.) appears to have ensured.

Although BBB proponents insist that the bill is close to deficit neutral over the ten-year budget window, CBO estimates that the measure would add $792 billion to the federal debt in the first five years after passage, with that amount partially offset in the second five years. So, in the short-to-intermediate term, BBB is inflationary. It only gets close to balancing if its various spending initiatives are not renewed by future Congresses.

But irrespective of how Congress reacts, the Fed should rethink its stimulative policies and allow interest rates to rise. Although there may be significant economic pain in the near-term, this is better than allowing inflation to become chronic, necessitating much more drastic action down the road.

A version of this column previously appeared in The Hill.

The post The Federal Reserve should rethink its stimulative policies appeared first on Reason Foundation.

A 6 milligram (nicotine)/30 milliliter bottle of e-liquid, for example, would be taxed at a rate of $5.01 under the proposal. A typical pack of e-liquid pods would be taxed at $4.59. The federal tax on cigarettes is $1.01 per pack. Thus, e-cigarettes would be taxed more than regular cigarettes, and dramatically more so in states that already levy their own high e-cigarette taxes. 

Michael Pesko of Georgia State University, one of the country’s leading economists when it comes to analyzing the effect of e-cigarette taxes, estimates the new tax on nicotine alternatives would cause 2.7 million more daily adult smokers, 530,000 more teen smokers, and 29,000 more prenatal smokers.

This is because e-cigarettes are substitutes, not complements to combustible cigarettes, and millions of American ex-smokers have used these products to get off smoking traditional cigarettes. 

“I think it makes sense to raise taxes on the most lethal forms of tobacco,” Pesko told Reason Foundation. “Unfortunately, this bill doesn’t do that. Instead, it raises taxes on one of the safer forms of tobacco and so the net public health impact of the tax is likely to be negative by pushing people toward more harmful combustible tobacco use.”

The Cochrane Review, the gold standard of evidence-based medicine, recently concluded e-cigarettes are probably more effective than traditional nicotine replacement therapies in helping smokers quit. “We are moderately confident that nicotine e-cigarettes help more people to stop smoking than nicotine replacement therapy or nicotine-free e-cigarettes,” they found.

From a public health perspective, rather than encourage traditional cigarette smokers to switch to nicotine alternatives that could improve their health, if implemented, this proposed tax seems certain to contribute to a greater incidence of lung diseases going forward.

As well as having a devastating impact on public health, the tax is highly regressive and would violate President Biden’s campaign promise not to raise taxes on people earning less than $400,000 a year. According to a recent Gallup poll, Americans with an annual household income of less than $40,000 are significantly more likely to vape than higher-income groups. Americans without a college degree are twice as likely to vape as college graduates. Those groups would be paying this tax increase.

With more than 15 million adult vapers now in America, many of whom attribute their ability to quit or reduce smoking traditional cigarettes to their use of e-cigarettes, it’s baffling House Democrats would consider targeting this group with a huge tax increase that could push many of them back to smoking and worsen public health.

The proposed tax increase won’t be worth causing 2.75 million more Americans to smoke and won’t generate much of the funding required to pay for the $2 trillion proposal. As the Tax Foundation’s Ulrik Boesen points out, a similar tax proposal from 2019 was estimated to raise less than $10 billion over 10 years. “The nicotine tax proposal in the Build Back Better Act neglects sound excise tax policy design and by doing so risks harming public health. Lawmakers should reconsider this approach to nicotine taxation,” Boesen concluded.

It is very difficult to understand why this proposed nicotine tax was included in the spending plan since it will have such negative consequences for public health, hurt low- and middle-income Americans, and break one of the president’s key campaign promises.

Sen. Joe Manchin (D, WV) opposes the tax and may be enough to ensure that it never becomes law. I second what Sen. Manchin said earlier this week, “A tax on nicotine? That doesn’t make any sense to me whatsoever.”

The post House Democrats’ tax on e-cigarettes would lead to millions more smokers appeared first on Reason Foundation.

According to a Senate Finance Committee legislative summary, the new tax would have applied to individuals with at least $1 billion of assets or at least $100 million of income for three consecutive years. The number of individuals falling into these categories across the United States appears to be less than 1,000. Instead of paying capital gains when they sell their assets, under the tax, affected individuals would have to revalue their assets each year and pay the federal government a percentage of any annual increase.

Internal Revenue Service records leaked to ProPublica showed that several high-profile billionaires pay relatively little in federal taxes. They can avoid taxation while maintaining luxurious lifestyles, in part, by retaining their appreciated assets and then borrowing against them.

Setting aside the question of whether a new tax targeting asset values of the very wealthy is the best solution, estimating the revenue it would raise is non-trivial, meaning basing government spending on that revenue is fraught. It may be tempting to look at the Forbes Billionaire Lists for two consecutive years, take the difference in estimated wealth for each billionaire on these lists and multiply by the tax rate. But such a top-line approach neglects various factors that could result in deficit-fueling revenues.

First, the proposed billionaire tax, if ever implemented, could then be temporarily stayed and ultimately thrown out by the judiciary on constitutionality grounds. Article 1 Section 9, Clause 4 of the Constitution says, “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.”

In modern terminology, this means that federal taxes on individuals or their property (“direct taxes”) must be the same amount for everyone. This clause was used to defeat the original federal income tax. Only after the passage of the 16^th Amendment could the federal government impose the income tax, which it did in 1913. The text of the amendment was short and straightforward:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Because the 16^th Amendment only makes an exception for income, any other direct tax, such as one on wealth, would appear to be unconstitutional. That said, courts have not struck down things like estate and gift taxes, and some legal scholars have defended the constitutionality of wealth taxes, although their arguments remain to be tested in court.

Proponents of the new levy likely structured it as a tax on unrealized capital gains rather than total wealth to protect it from being overturned. But undoubtedly, some billionaires would recruit the best legal minds money can buy to try to defeat it.

Moving ahead, assuming the tax is passed and the Supreme Court neither strikes down the unrealized capital gains tax nor delays its implementation, there are still other risks to the revenue forecasts. Most notably, some billionaires may leave the United States and renounce their citizenship to avoid the new tax.  According to fintech startup Stilt, 5,313 Americans renounced their citizenship in 2020. Each quarter, the IRS publishes a list of individuals who have given up their citizenship or their U.S. resident tax status. Among the people who have appeared on these quarterly lists — rock star Tina Turner, Facebook co-founder Eduardo Saverin, and Campbell Soup heir John Dorrance III, the latter two of these individuals were billionaires when they gave up their U.S. passports.

More billionaires can likely be expected to initiate the renunciation process if their U.S. tax liability were to increase as it would under the billionaire tax proposal. At least a few are already well-positioned to take this step. For example, Peter Thiel has reportedly obtained New Zealand citizenship, while former Google CEO Eric Schmidt has obtained a European Union passport. With a total tax base of fewer than 1,000 individuals, the departure of just a few taxpayers could significantly impact revenue collections from a billionaire tax.

The Senate Finance Committee draft partially addressed the renouncement issue by requiring billionaires who give up their citizenship to pay any unrealized capital gains tax before leaving. If such a requirement passed legal muster and could not be circumvented, it would compel billionaires to pay taxes on their past gains but the federal government would still be deprived of revenues from future capital gains.

Finally, capital gains taxes may generate strong revenues when the economy is booming and could produce very little revenues during recession years.

It was wise for Congressional Democrats to shelve the billionaire tax proposal, but the issue seems certain to reemerge down the road. If and when it does, taxpayers should be skeptical that the tax would produce the revenues some proponents claim it would, especially in the absence of a CBO score.

The post Reasons to be skeptical of the potential revenues from the proposed billionaire tax appeared first on Reason Foundation.

This plan has raised questions as to whether it will break Biden’s promise not to raise taxes on low-and-middle-income Americans. Others wonder how such a tax hike would affect the FDA’s strategy to reduce smoking and what will happen to state tobacco tax revenues.

This Reason Foundation panel discussion, which took place on October 26th, 2021, featured economists and law enforcement experts as they discussed the answers to these questions and more. The panelist included:

• Guy Bentley, Director of Consumer Freedom Research, Reason Foundation
• James E. Prieger, Professor of Economics and Public Policy, Pepperdine University
• Major Neill Franklin, Former Executive Director, Law Enforcement Action Partnership
• Ulrik Boesen, Senior Policy Analyst, Tax Foundation

The full discussion is available for viewing here: Can higher tobacco taxes help pay for the reconciliation bill?

The post Watch panel discussion: Can higher tobacco taxes help pay for the reconciliation bill? appeared first on Reason Foundation.

In the current House and Senate showdown, Sen. Joe Manchin (D-WV) has emerged as the crucial centrist “swing vote.” Sen. Manchin recently proposed sweeping changes to the still-new child tax credit, including reducing the ceiling for eligible families dramatically—to only those earning under $60,000 per year—and adding a work requirement for recipients.

Last month on CNN, Sen. Manchin said the tax credit had “no work requirements whatsoever” and asked, “Don’t you think, if we’re going to help the children, that the people should make some effort?” This sentiment surrounding work requirements has proven politically potent for decades and, at least at first pass, seems to be built on economic common sense. These concerns also resonate with many people right now because during the COVID-19 pandemic unemployment insurance benefits became more generous and many are observing a shortage of workers, especially in service industries.

However, recent history shows that work requirements for cash assistance to poor Americans often work much better as political sloganeering than as real programs. For example, the Temporary Assistance for Needy Families (TANF) program, instituted in the mid-1990s, added work requirements to the cash assistance program formerly known as American Families with Dependent Children (AFDC). Despite persistent conventional wisdom that benefits should be tied to a willingness to work, the benefits of this major shift were modest and uneven. The results were so weak as to indicate if the ultimate policy goal is helping families emerge from poverty in robust and self-sustaining ways, unconditional benefits may be a better solution.

The same would likely be true of Sen. Manchin’s proposed child tax credit reforms, which should be rejected even in the current climate of labor shortages in some sectors. The “get a job” mentality Manchin imposes, when put into practice, would only result in cosmetic improvements to employment rates and the size of the welfare state. In addition to fewer monthly checks, Manchin’s proposed reforms are a step back in our thinking and framing of debates regarding poverty and work.

The Same Mistakes

In our complicated welfare system, consisting of dozens of programs combining various cash and in-kind benefits with an array of differing eligibility and behavioral requirements, calculating the cash impact of the child tax credit on the “average” recipient family is difficult. But what emerged following this spring’s earlier round of legislative wrangling was a tax credit that differed from other assistance programs currently on the books in three important ways:

• Eligibility for families with higher incomes than existed in other assistance programs;
• A lack of requirement that any member of the family be working or looking for work;
• A simpler and less bureaucratic system.

Sen. Manchin’s proposed changes take aim at the first two characteristics of the child tax credit. However, his lack of specifics obscure the fact that even a well-designed approach to rolling back those first two characteristics impacts the third. Based on past welfare reforms, Manchin’s requirements would mean a system with a bigger bureaucracy that is far more expensive to run and rife with benefit cliffs and loopholes with unintended consequences.

Eligibility for a means-tested program is always more complicated than earnings above or below a single number. How many earners does the family have? What income gets counted? What about other benefit programs? Beyond the income ceilings, do benefits phase out gradually or simply fall off a “benefit cliff?” Beyond the $60,000 figure, Manchin has not answered these questions.

The current child tax credit begins phasing out benefits at higher incomes: $112,500 for single parents and $150,000 for joint filers. It then phases out very gradually, with partial benefits available to single parents and couples earning as much as $200,000 and $400,000, respectively.

Many frame this eligibility over wider income brackets as “paying people not to work.” That isn’t quite correct. Beneficiaries are being paid, which impacts work and other life decisions, but their work decisions on the margin are left to them as free decision-makers with richer knowledge about themselves and their circumstances than policymakers have. Steep benefit cliffs at lower income thresholds are where policy actually impacts those marginal decisions more sharply and creates top-down disincentives to work.

The work requirement called for by Sen. Manchin adds additional bureaucratic strain. The Internal Revenue Service (IRS) can issue checks directly, but a major bureaucratic undertaking is needed to determine who is and isn’t working, is or isn’t looking for a job, and does or doesn’t have some exemption or extenuating circumstance.

Manchin’s direct, yet also vague, call for a “work requirement” for the child tax credit is therefore problematic over his other proposed changes. The experience of the TANF program is instructive, as it was born when such a work requirement was added to the federally-funded but state-administered AFDC cash assistance program. In the years following the change, welfare rolls were cut by several million recipients but the bureaucracy and overall spending only grew. 

Different Results

The shortage of service workers as the nation tries to emerge from the COVID-19 pandemic might appear to some supporters of work requirements as further evidence of their importance. In the wake of extended unemployment benefits and the introduction of the child tax credit, it can look to many like we are indeed paying people not to work. But this story becomes more complicated when viewed as millions of heterogeneous individuals and jobs in a complex economy.

Based on an interview with Indiana University economist Kyle Anderson, Indianapolis Star reporter Binghui Huang writes that the “reasons range from fear of COVID-19, child care needs at home, mismatch of skills between the worker and the job, changing career interests and early retirement.”

We should instead approach the labor shortages currently observed as a question similar to the general supply-chain dislocations also in the news. Indeed, unfilled jobs and cargo ships stuck outside ports are two aspects of the same problem. Writing for Reason Foundation, Marc Scribner illustrates step-by-step a scenario of “cascading impacts” from COVID-19 that lead to such problems in product markets. Scribner is rightly concerned about big policy gestures making the problem worse:

“With the public and businesses feeling the impacts of supply chain problems and news stories already scaring parents that their Christmas toys may not arrive in time for the holidays, politicians are likely going to continue wanting to show they are doing something about the problem by holding summits with business and labor leaders, appointing “czars,” and engaging in other photo opportunities to present the illusion that they can solve these problems. But the reality is supply chain problems are largely out of policymakers’ control and almost certain to continue through 2022. Markets and businesses will adjust but not on a dime.”

Counseling patience in today’s political and media environment may be an uphill climb, but Scribner is exactly right about both the product and labor markets. COVID-19 hit the complex system of our modern economy with countless shocks. In both product and labor markets, the bottom-up process of finding a robust new normal has no shortcuts. 

All the more reason for assistance to workers that is dependable and does as little as possible to distort specific decisions on the ground. Both the left and right are attracted to policies designed to make people do what they think people should do, but avoiding this trap is good advice both in our peculiar current set of affairs and in general. We have seen enough examples of the futility of more top-down micro-managed approaches to expect different results.

The post Sen. Manchin’s proposed reforms to the child tax credit would be a step back in fighting poverty appeared first on Reason Foundation.

The nation’s attention has recently been on the rising national debt due to congress raising the debt ceiling. As Reuters reported:

The U.S. Senate approved legislation on Thursday to temporarily raise the federal government’s $28.4 trillion debt limit and avoid the risk of a historic default this month, but put off until early December a decision on a longer-lasting remedy.

The two major political parties may have different priorities, but when in control of the White House and Congress, they both present false choices of the debt ceiling that sound something like, ‘We have to raise the debt ceiling this time to avoid defaulting on our national debt because we can’t reduce any spending anywhere on any of our preferred programs and priorities while we’re in control of the government.’

Eventually, this piling up of debt and the runaway federal spending must be stopped. For decades members of Congress and presidents have demonstrated their unwillingness to control their debt-financed spending. When they have the opportunity to make and follow policies to restore prudent fiscal management and accountability, they choose instead to spend on their pet policies. At some point, those in the federal government need to learn to live within their, i.e. taxpayers’, means. Unfortunately, there is nothing in the U.S. Constitution requiring them to do so. When the Constitution was ratified, the federal budget was only $4 million. Today, the federal budget is $4 trillion.

As the national debt nears $29 trillion, the conversation about this problem needs to change. Article V of the Constitution provides that two-thirds of the states may call a Convention of the States to propose one or more amendments to the U.S. Constitution, without the approval of Congress, to impose and maintain fiscal responsibility upon the federal government. If such a convention were called, 38 states would then have to ratify any constitutional amendments for them to become part of the U.S. Constitution.

Such an outcome may seem quite improbable in the current polarized political times. But, throughout history states have acted several times in this way. There are debates amongst legal scholars over how specific or similar resolutions calling for a convention of the states must be. Under some counts, 33 states have passed resolutions calling for an Article V convention, and a 34^th state, creating the needed two-thirds majority, seems likely to pass it next year. In terms of a specific resolution, in 2019, the Colorado Fiscal Institute said states were getting close to the needed number on a balanced budget amendment:

The Balanced Budget Amendment Task Force (BBATF), one of the primary groups working towards a balanced budget amendment, began in 1957 when Indiana passed the first Article V resolution on this topic. Today, 28 states – including Colorado – have passed resolutions calling for a convention to discuss a balanced budget amendment. That means if six more states call for a balanced budget amendment, a constitutional convention could be convened. Idaho, Kentucky, Minnesota, Montana, South Carolina, Virginia, and Washington have all been targeted by BBATF.  

The process of creating a constitutional convention to consider amendments to constrain federal spending and debt would likely radically change the tired existing debates around federal spending and the national debt. A convention would also be a real opportunity to finally create some sensible constraints on federal spending and taxation, requiring sensible financial management, transparency, and accountability from the federal government. 

When political leaders are ready to address these issues, we have developed a package of proposals, The Bill of Financial Responsibilities, showing how they can start to tackle the nation’s troubling debt.

The post The growing need to structurally address the national debt appeared first on Reason Foundation.

The delay in utilizing the COVID-19 stimulus funds suggests that state and local governments were, by and large, not facing the severe financial emergencies that proponents of federal stimulus insisted they were when the federal legislation was being debated. Further, data show that the state and local aid components of ARPA had little effect on second-quarter 2021 gross domestic product growth and likely had a minimal impact on third-quarter economic activity.

Although the 142 reports our researchers reviewed represent a small fraction of governments that had to report in time for the Treasury Department’s next deadline, Aug. 31, the state and local governments in our sample were predominantly larger units that are receiving the bulk of the federal assistance. 

We obtained the reports by visiting city and county websites, using state and territorial reports gathered by the National Association of State Budget Officers (NASBO), and filing a limited number of public records act requests. The local government reports are available here. Since U.S. Treasury rules instruct state and local governments to post their expenditure reports on the web as well as filing them with Treasury, it appears that many governments have yet to do so. The Treasury Department could post all the reports and aggregated data it has available on its own website—and says it plans to do so on or about Oct. 15. 

When reporting their information, the Treasury Department instructed state and local governments to include a table of categorized expenses, providing a list of 74 possible designations for their spending. The most heavily used categories in the reports filed were:

Note these rankings exclude federal funds that states transferred to their local governmental units. Reporting by lower-level governments on these so-called “Non-Entitlement Units” are not due until Oct. 31.

The slow rate of spending seems inconsistent with the belief in some political and policy circles that state and local governments urgently needed large amounts of federal aid to address fiscal emergencies. For example, a White House fact sheet, published in January as the bill was being debated, stated:

President Joe Biden is calling on Congress to provide $350 billion in emergency funding for state, local, and territorial governments to ensure that they are in a position to keep front line public workers on the job and paid, while also effectively distributing the vaccine, scaling testing, reopening schools, and maintaining other vital services.

Similarly, in February, House Majority Leader Stenny Hoyer (D-MD) issued a news release that said, in part:

The American Rescue Plan will provide crucial funding for state and local governments after a year of record revenue shortfalls and devastating budget cuts. Leaders on both sides of the aisle continue to raise alarm over the urgent need for assistance for state and local governments…

But as we observed at the time, evidence from state and local government revenue reports as well as Census Bureau surveys indicated that calendar year 2020 revenues were little changed from the prior year. In retrospect, it is now clear that $350 billion in federal aid was far more than state and local governments needed to offset any COVID-19 revenue losses. 

Because we only have a sample of the spending data, and therefore do not yet know exactly how much was spent before June 30 (the end of the second quarter), we can only offer some very rough approximations of the second quarter GDP impact of American Rescue Plan Act state and local assistance. Assuming that state and local governments spent $10 billion of ARPA funds in Q2 2021 and that this spending had a GDP multiplier of 1.34 (as estimated by Moody’s Analytics), the economic impact of this program amounted to only about 0.2% of that quarter’s GDP.  Unless spending ramped up substantially in August and September, the third quarter economic impact of the American Rescue Plan Act is also likely to be minimal.

Even still, the Moody’s multiplier and thus the GDP impact estimates are likely overstated because the biggest application of the federal aid has been to backfill depleted state unemployment trust funds. While replenishing unemployment funds is a sensible policy decision that will stabilize unemployment tax rates in the future, it does not result in any immediate spending.

These findings also offer reasons for caution and arguments against making major federal fiscal policy in haste before gathering and analyzing relevant information. But now that it has obligated $350 billion in aid, does Congress have any options to improve the performance of this program?

Congress isn’t going to go back and pass a bill requiring state and local governments to return unspent portions of the American Rescue Plan Act. But one reason the money is being spent slowly is that it came with so many strings attached as Congress limited how state and local governments could allocate the aid in various ways.

Congress could allow a state or local government to return a percentage of the funds it has received in exchange for allowing it to use the remaining federal funds without any of the restrictions in the American Rescue Plan Act. Since this would be offered as an option, it need not affect any state or local government whose leaders believe they can and should spend the aid in accordance with the existing restrictions. But, cities or states that think they could more effectively and efficiently spend federal aid could buy their way out of the ARPA-imposed limitations.

It is increasingly clear that state and local governments didn’t need the federal aid they’ve received. Congress should look for opportunities to save taxpayers money and ensure the federal aid is spent in the most useful ways possible.

The post Disclosures reveal state and local governments haven’t spent federal rescue funds appeared first on Reason Foundation.

The proposed tax increase attempts to equalize the taxes on all nicotine products—regardless of their risk, use patterns, or approval by the Food and Drug Administration. Taxes on combustible cigarettes would double to $2 per pack under the bill’s current form. The tax on dipping tobacco, roll-your-own tobacco, and pipe tobacco would rise by 2,023 percent, 100 percent, and 1,651 percent, respectively.

Vapor products, which are not currently taxed at the federal level, would be taxed at a rate of $100.66 per 1,810 mg of nicotine to align them with taxes on traditional cigarettes. Thus, the tax on a typical pack of e-cigarette pods would be around $9, and a 30-milliliter bottle of 12-milligram e-liquid would be taxed at $20.02. Federal taxes on small cigars would increase by 100 percent under the proposal, but larger and premium cigars could see up to a 1,000 percent tax increase. 

Two already products approved as “appropriate for the protection of public health” by the FDA would also see tax increases. The tax on heated tobacco products would increase 100 percent and the smokeless tobacco, snus, would incur a 2,892 percent tax increase on a can of 24 pouches.

These sweeping tax hikes would break the Biden administration’s campaign pledge that it would not raise taxes on low and middle-income Americans. The tax increases also contradict the FDA’s smoking reduction strategy, would undermine public health efforts, and cause job losses across the country.

Tobacco Tax Hikes Are Regressive

On the 2020 campaign trail, now-President Joe Biden frequently pledged to not raise taxes on individuals earning below $400,000 a year. However, cigarette taxes are acknowledged to be one of the most regressive taxes at both the state and federal levels. Almost three-quarters of America’s 34 million smokers are from low-income communities. According to the Joint Committee on Taxation, 94.3 percent of consumers who would be paying more in tobacco taxes make under $200,000 a year.

If the congressional tobacco tax proposal were to pass, a pack-a-day smoker in New York state making $15,000 a year would pay almost 20 percent of their yearly income to tobacco taxes, according to the Tax Foundation. In West Virginia, the state with the highest smoking rate in the nation, that figure would be more than 10 percent.

Smoking is concentrated among blue-collar workers without college degrees. For example, about 35 percent of those with only a GED smoke while only four percent of individuals with a graduate degree smoke. It would not be an understatement to say that the dramatic tobacco tax increase is strongly supported by high-income Americans with advanced educations but would be paid for by low- and middle-income Americans who didn’t go to or graduate from college. 

Under even the most optimistic assumptions by public health groups, 97 percent of smokers would continue smoking despite the proposed increased tax. However, these assumptions don’t account for those currently using safer nicotine alternatives switching back to smoking because the price advantage of using e-cigarettes and other devices would have been eliminated. The revenue raised from these taxes would be a fraction of the cost of the president’s Build Back Better agenda but would significantly impact the pocketbooks of tens of millions of Americans. 

Congress’ Proposal Contradicts the FDA’s Strategy for Tobacco Harm Reduction

Equalizing taxes across all nicotine products, regardless of their risk to users, runs counter the FDA’s strategy to reducing tobacco-related public health harms. The FDA’s plan to reduce smoking is based on the “continuum of risk,” which recognizes that not all nicotine products are created equal. Cigarettes are the most dangerous nicotine product, not because of the presence of nicotine but because of the smoke that results from combustion. Nicotine replacement therapies like gums are some of the safest.

Writing in the journal Tobacco & Nicotine Research, the head of the Center for Tobacco Products Mitch Zeller said:

“FDA’s new strategy promises to save millions of lives by accelerating declines in smoking among those currently addicted, while preventing future generations from becoming addicted to cigarettes in the first place. Primary objectives include helping people move away from the tobacco product that causes the most harm—cigarettes—and encouraging industry resourcefulness in developing potentially less harmful products for adults who seek nicotine.” 

Zeller told Congress, “If we could get all those people [who smoke] to completely switch all of their cigarettes to noncombustible cigarettes, it would be good for public health.”

The FDA has already authorized two such products; IQOS, and general snus, both of which are allowed to inform consumers of their benefits relative to cigarettes. E-cigarettes are currently under FDA review. Increasing taxes on e-cigarettes so dramatically before the FDA has completed this process risks severe consequences for the roughly 15 million adult vapers in the U.S. 

Further, a study conducted by health economists at Georgia State University estimated that equalizing taxes on e-cigarettes and combustible cigarettes could deter 2.75 million Americans from quitting smoking. 

In August, 15 past presidents of the Society for Research on Nicotine and Tobacco (SRNT) led by the University of Michigan School of Public Health’s Kenneth Warner took to the pages of the American Journal of Public Health (AJPH) to warn that the potential of e-cigarettes to save lives was being lost and that nicotine products should be taxed “proportionate to risk.”

Increased Tobacco Smuggling Could Threaten Community Safety

The illicit cigarette trade currently represents about a fifth of the entire market and deprives states and localities of between $3 and $7 billion in tax losses annually. Doubling the federal excise tax will undoubtedly increase the illicit market for tobacco products. One of the main concerns with increased illegal activity is national security and domestic organized crime. Because tobacco trafficking is a low-risk, high-reward activity, it’s especially attractive to criminal syndicates and terrorist networks. 

In 2015, a State Department report warned of the increasing danger such a lucrative criminal enterprise posed to U.S. security: 

“Internationally, it fuels transnational crime, corruption, and terrorism. As it converges with other criminal activities it undermines the rule of law and the licit market economy and creates greater insecurity and instability in many of today’s security “hot spots” around the world. Illicit tobacco provides a significant revenue stream to illicit actors without the high risks and punishments associated with trafficking in narcotics or humans.”  

Border states such as California, Arizona, New Mexico, and Texas are particularly vulnerable to the illicit tobacco trade. Tobacco taxes are significantly lower in Central and South America, and established pathways for narcotics trafficking can be utilized to smuggle cigarettes.

Tax Increases Hurt Small Businesses and Can Lead to Job Loss

Because of varying patterns of use and price elasticities between different tobacco products, the economic impact of the proposed tobacco tax will have diverse effects. For example, analysis by Chmura Economics & Analytics shows cigarette volumes will fall 6.4 percent. But cigar volumes will decline 55.9 percent, and vapor volumes will decline by 34.4 percent. Such declines represent a significant threat for the thousands of cigar and vape shops across the country as well as all-purpose tobacco retailers. 

According to Chmura, the Tobacco Tax Equity Act would cost 14,030 jobs. The states that would be hit hardest in terms of job losses are Florida, California, Georgia, North Carolina, Texas, and Ohio. 

Conclusion 

If one of the goals of the proposed reconciliation bill is to help low and middle-income Americans, large increases in tobacco and nicotine taxes will undermine this objective. As the Institute on Taxation and Economic Policy outlined in its modeling of the Build Back Better Bill “…tax increases on tobacco and nicotine would clearly fall most heavily on low-income smokers.”

Unfortunately, the Tobacco Tax Equity has not been subjected to sufficient analysis or scrutiny to determine whether the potential benefits outweigh the costs. From a public health standpoint, equalizing or, indeed, taxing lower-risk nicotine products more than combustible cigarettes disincentivizes switching away from more harmful products. As such, the status quo federal excise tax on tobacco products, despite a number of flaws, still remains preferable to the tax increases proposed in the Tobacco Tax Equity Act.

The post Four reasons to reject a federal tobacco tax increase appeared first on Reason Foundation.

But legislation recently released by the House the Ways and Means committee flies in the face of Biden’s cast-iron guarantee with an eye-watering increase to the federal tobacco tax. Cigarette taxes would double to more than $2 per pack under the House proposal. In addition, all other nicotine products, regardless of whether the Food and Drug Administration has approved them as “appropriate for the protection of public health,” would be taxed at the same rate as cigarettes. 

So far, the White House has refused to commit to the legislation.

Around 34 million Americans currently smoke, and three-quarters of smokers are from low-income communities. Smokers are significantly less likely to have a college degree and more likely to work a blue-collar job. The smoking rate in the LGBTQ community is 20 percent, compared to the national average of 14 percent. And there’s no question that a hike in the tobacco tax would be regressive, with almost all smokers making less than $400,000 per year.

For some, the regressivity of cigarette taxes is their biggest selling point. Speaking about so-called sin taxes in 2018, former New York City Mayor Michael Bloomberg said, “Some people say, well, taxes are regressive. But in this case, yes they are. That’s the good thing about them because the problem is in people that don’t have a lot of money.” 

There is no doubt high cigarette taxes can reduce some cigarette consumption, as proponents of the taxes hope. But even high taxes don’t push most smokers to quit. Thus, even under the most optimistic scenarios about how many smokers would quit smoking in response to the tax increase, millions of low-income Americans would pay higher taxes if the proposed legislation goes into effect. 

The constituents of Sen. Joe Manchin (D-WV) would be particularly hard hit by the tax. So, like so many other Democratic priorities in Congress right now, the fate of the House bill could ultimately rest in Manchin’s hands if it reaches the Senate. The poverty rate in Manchin’s state of West Virginia is above the national average at 16 percent. There are 15 states with lower cigarette taxes than West Virginia, yet it still has the highest smoking rate in the nation. The proposed federal cigarette tax would see a pack-a-day smoker in West Virginia pay almost $400 more in taxes a year, for a total of $1,593 per year. That’s 10.6 percent of the annual income of a low-income smoker making $15,000 a year.

Some may be tempted to cheer for the tax increase if, in the end, it prevents more deaths from smoking. But what’s especially disturbing about the new proposal is that it would also tax safer alternatives to traditional cigarettes, like e-cigarettes and heated tobacco products, at the same rate as cigarettes. For example, the federal tax on a pack of 5 percent nicotine Juul pods would be $9.18. 

Extensive research shows e-cigarettes are dramatically safer substitutes for traditional cigarettes and effective in helping smokers quit. According to researchers at the City University of New York and Bentley University, taxing e-cigarettes at the same rate as cigarettes would deter 2.75 million people from quitting smoking. E-cigarettes are currently under review by the Food and Drug Administration and some could soon be approved as “appropriate for the protection of public health.”

The FDA has already approved two tobacco products as being net beneficial for public health because they are less toxic than cigarettes and a pathway out of smoking. But the tax proposal from the House Ways and Means would treat these products the same as combustible cigarettes. The policy turns the logic of sin taxes on its head by penalizing consumers who are consuming a less dangerous product. 

Hiking cigarette taxes on an unpopular minority may be welcome among a large group of taxpayers—the wealthier, college-educated, non-smoking, non-vaping part of the electorate. Still, the proposed cigarette tax increase is almost uniquely targeted at some of the very people Democrats in Congress said they would protect from tax increases.

The post Congress considers tobacco tax increase appeared first on Reason Foundation.

The 2009 American Rescue and Recovery Act set a precedent for linking major government spending initiatives with fiscal transparency. The Obama administration created a website called recovery.gov to detail how the stimulus funds were being spent. Although that site was shut down in 2015, an archived version is available from the Library of Congress. Much of the functionality of recovery.gov has been incorporated in the federal government’s primary spending transparency website, usaspending.gov, which has more recently been updated to report on federal spending related to the COVID-19 pandemic.

Although usaspending.gov is a great resource for understanding how the federal government is allocating emergency COVID-19 related stimulus funds, taxpayers and researchers will need to consult state and local resources to see how these governments are spending their shares of the $350 billion of ARPA dollars. In Delaware, State Auditor Kathleen McGuiness has launched a website that allows the state and local governments to report ARPA spending.

The Delaware transparency platform, branded as Project: Gray Fox, is powered by OpenGov, a company that creates and maintains budget visualization sites for a large number of local governments across the country. Governments interested in launching transparency portals can build them with internal programming staff or leverage open source technologies such as Aragón Open Data or OpenSpending but using an experienced software vendor is likely to be the quickest way to launch for most governments. Aside from OpenGov, the fiscal transparency market is also served by ClearGov and Socrata (now a part of Tyler Technologies).

Once fully built out, Delaware’s Gray Fox will contain ARPA spending data from the state, 19 K-12 school districts, 23 charter schools, three counties, and 57 municipalities. At this point, many local governments have not developed plans for spending the federal aid they are receiving, let alone having made any expenditures. But once they begin spending ARPA funds, they will be able to upload their spending information to a user-friendly page on the Gray Fox platform.

Users will be able to see individual expense items with data points including the date of each expense, the type of goods or services provided, and the name of the supplier or vendor. At an aggregate level, the dataset promises to provide interesting insights into how spending is being prioritized by Delaware and which government contractors are benefiting the most. McGuiness tells me she hopes that the Gray Fox site can reduce the number of Freedom of Information Act requests from journalists and citizens interested in tracking ARPA spending, which would reduce the time state and local government employees would otherwise have to spend fulfilling these requests.

Another benefit of the platform is that it allows most participating governments to generate annual project and expenditure reports required by the U.S. Department of the Treasury under ARPA. The new capability can be used by smaller governments, i.e., those with 250,000 or fewer residents, which must begin filing these reports on October 31, 2021.  All local governments in Delaware, with the exception of New Castle County, fall within this definition.

McGuiness says she also hopes that the initiative will set a precedent for governmentwide financial transparency around Delaware. In recent transparency scorecards produced by the US Public Interest Research Group (PIRG), Delaware has not been among the leaders. For checkbook transparency, Delaware ranked 44th in 2016 but improved to 17th in 2018. In 2019, PIRG gave Delaware a grade of D+ for its reporting on economic development subsidies, which can take the form of direct cash payments or tax concessions. McGuiness sees potential for the Gray Fox Initiative to create a new culture of transparency that will yield higher rankings for the state in future surveys.

Whenever the next economic downturn arrives, taxpayers can expect some to call for another injection of federal funds into state and local government balance sheets. Better transparency could well inform a future debate over federal assistance, helping us understand how and when today’s funding is being used and whether or not there’s a need for additional federal aid.

Correction: This post originally incorrectly identified Project: Gray Fox as the Gray Fox Initiative, miscredited OpenGov with building Project: Gray Fox, and misstated the number of counties and municipalities in Delaware. It has been updated.

The post Delaware tries to improve transparency on state spending appeared first on Reason Foundation.

President Biden has called for upping the corporate tax rate from 21 percent to 28 percent. While that’s still lower than the country’s corporate tax rate prior to the 2017 tax cut bill, which was then 35 percent, it’s a bad idea. At 28 percent, the federal corporate tax rate, combined with state corporate taxes, would be over 32 percent, putting the U.S. back to having the highest corporate tax among the highly-developed OECD, Organization for Economic Co-operation and Development, nations. For example, Canada’s corporate tax rate is 15 percent and Mexico’s is 30 percent. One outcome of Biden’s proposed tax hike would be more corporations looking to move out of the U.S. to lower-tax countries.

Decades of research also show higher corporate tax rates get passed on to workers, who end up paying the majority of the costs in the form of lower pay and benefits. The Tax Foundation estimates Biden’s corporate tax increase would eliminate 159,000 jobs, reduce long-run economic output by 0.8 percent and wages by 0.7 percent, with the bottom 20 percent of earners on average seeing a 1.45 percent drop in after-tax income in the long term.

Biden also wants to raise taxes on the wealthiest Americans. “Anybody making more than $400,000 will see a small to a significant tax increase,” Biden recently said to ABC.

Raising taxes on the wealthy consistently polls well with voters of both major political parties, but it’s a bad policy that doesn’t work as intended. An analysis in the Quarterly Journal of Economics of decades of data shows that tax increases on individual incomes reduce average incomes and economic activity, but the effect is the fastest and largest when taxing the top one percent. The so-called 1990 luxury tax, for example, killed so many jobs that the federal government actually lost revenue because of it. That is because the rich do not sit on mountains of gold in their vaults, as some might imagine. Most of their money is either invested or spent so raising taxes on the rich lowers consumption and all the jobs that creates, and lowers investment and all the jobs that creates. Hence, the top one percent pay considerably more in income taxes than the bottom 90 percent of taxpayers combined.

The country is expecting significant economic growth this year as more Americans are vaccinated and able to travel to visit loved ones, go on vacations, eat in restaurants and attend things like sporting events. Tax increases would undercut this growth by taking money that would be invested in expanding existing businesses or opening new ones.

President Biden and Republicans need to show some seriousness about dealing with the nation’s debt and deficits. In the debate leading up to the recent $1.9 trillion spending bill — which came after President Trump’s own $2.2 trillion stimulus bill and four years running up debt and deficits — the GOP could not credibly claim it cared about debt and deficits. Republicans and conservatives “ditched any semblance of fiscal restraint during the last four years of economic expansion (i.e., precisely when it’s easiest to cut spending),” Scott Lincicome recently noted in his newsletter for The Dispatch.

Spending cuts are needed and the country’s massive defense spending, over $700 billion a year, is ripe for cutting. A group of House Democrats is urging Biden to trim the Pentagon’s budget. Unfortunately, Republicans want more, not less, spending. “The problem with decreased or flat defense budgets is that our adversaries aren’t looking at cutting defense spending. It’s the opposite,” Rep. Mike Rogers, the leading Republican on the House Armed Services Committee, claimed.

As a military veteran I’d argue he is wrong because our current military is more than capable of defending our nation and, if we stopped our absurd and broken attempts at nation-building overseas, our defense budget is more than adequate already.

If Republicans aren’t going to support ending our forever wars and reducing defense spending, they should at least try to ensure that any big infrastructure and spending bills embrace the user-pays principle and utilize public-private partnerships. Raising the federal gas tax is counterproductive — as vehicles become more fuel-efficient — and politically unpopular, but private companies and private equity firms are ready to invest billions in major infrastructure projects.  From water and sewer systems to roads and bridges, infrastructure can be built via public-private partnerships using private capital and charging user direct fees to pay for it.

Users don’t pay any more than they would’ve otherwise, the projects get built faster, private investors take most of the financial risks of losses if something goes wrong with the project, such as delays and cost overruns, and the companies can make a profit if they deliver the project efficiently.

Infrastructure projects that are paid for by users, not by federal taxes, can be a big boost to the economy. Combining this approach with some smart realignment of other federal spending would allow President Biden to achieve his policy goals without the harmful tax cuts he is considering and the consequent blow to the economy and to lower-income workers.

A version of this column previously appeared in the Daily Caller. 

The post Instead Of Tax Increases, President Biden Should Cut Spending And Use Public-Private Partnerships appeared first on Reason Foundation.

The data void at the federal level regarding the fiscal position of state and local governments is not due to the absence of state and local government financial data. All states and most sizable local governments produce annual audited financial statements, but these usually appear 6-9 months after the end of the fiscal year. Most states and a few local governments produce monthly or quarterly financial reports—typically on a cash basis and limited to general fund activity—with a much shorter time lag.

Most annual audits comply with pronouncements from the Governmental Accounting Standards Board yet appear in widely varying formats. Interim reports are not governed by national standards and lack even a modicum of consistency.

The Securities and Exchange Commission (SEC) has raised the issue of stale municipal financial disclosure in recent years. For example, an SEC transparency subcommittee observed:

[T]he average municipal issuer provided its annual financial information within 12 months of the end of its fiscal year provided such annual information 188 days after the end of the applicable fiscal period. If a municipal issuer does not provide interim financial disclosures and it files its annual financial disclosures within the averages referenced above, the financials available to investors could be over 500 days old as the next submission date approaches.

During the coronavirus pandemic, the lack of timely and standardized state and local disclosure prevented policymakers from quickly determining with any degree of accuracy how much revenue was lost as the pandemic unfolded.

If every state, major city, and county produced monthly cash reports in a standardized, machine-readable format within two weeks of month-end, federal policymakers would have had a much better picture of how revenues and expenditures are evolving.

At the federal level, the Treasury Department shows the way by producing its Monthly Treasury Statement in Excel format each month. Excel files are easier to parse and thus consolidate than Adobe PDF files. Even better than Excel are non-proprietary formats such as CSV, JSON and XML. All of these options are supported by Treasury’s new FiscalData website, which includes an exportable dataset of Monthly Treasury Statements.

Among states, Texas provides its monthly state revenue collections in both Excel and CSV formats. Connecticut offers a monthly revenue data set exportable to Excel, CSV and XML formats. Local governments are generally less advanced, but New York City—as the nation’s biggest city—does provide extensive revenue and expenditure data in a Google Sheet updated quarterly.

If the nation’s 200 largest state and local governments provided data like this, the vast majority of state and local financial activity would be available in near real time. But collecting this data would still be non-trivial due to variances in the number, type and identification of the data elements provided. Ideally, of course, all state and local governments would adopt a single reporting taxonomy (i.e., data dictionary) that could be readily consolidated. Our Standard Government Reporting working group at XBRL US has produced a draft taxonomy for annual financial reporting. A small subset of items from this taxonomy could be applied to monthly reporting. Our taxonomies can be used with CSV, JSON and human-readable HTML reports.

In the absence of this standardization, data collection is typically handled by organizations that are willing to make the investment of time and energy to process all the varying government disclosures. This too often means that compilations are not available to the public for free or that the data is selectively reported in support of a certain political narrative (e.g., state and local governments are suffering and need a large federal aid package, or they are doing just fine and do not require a bailout).

The federal government—through the Census Bureau—undertakes a parallel data collection effort which is likely free of commercial or ideological motives. The Census Bureau conducts an Annual Survey of State and Local Government Finance and produces a Quarterly Summary of State and Local Tax Revenue. Unfortunately, these products appear after significant time lags, and because they are based on separate data collection instruments than those of state and local governments they may not fully agree with public financial reports issued by each state and local government. The Census Bureau’s efforts could be improved by the availability of public, standardized, machine-readable data

Commercial and ideological players also dominate the discussion of projected revenue losses and spending, using proprietary models to reach their findings. There’s nothing wrong with that, but as we learned during the global financial crisis of 2007-08, if government agencies rely on proprietary models operated by self-interested parties with financial stakes in the game, these models can help produce unacceptable results for taxpayers. Although the Congressional Budget Office is not always correct, it has achieved a level of openness and objectivity that instills confidence across most of the ideological spectrum. As federal involvement in state and local finance increases, citizens need institutions whose analyses and projections of state and local government finances would be met with similar levels of confidence. Perhaps CBO could expand into this area, or a non-ideological, non-profit could take on this challenge. In any case, taxpayers should have easy access to the data and modeling software code and assumptions would ideally be placed in the public domain so that third parties could fully review the analysis.

Economic historians will ultimately weigh in on the question of whether the American Rescue Plan’s $350 billion state and local aid component was reasonably sized and allocated. For those of us condemned to live in the present and without the benefit of hindsight, we should be taking every opportunity to improve our data and analytics to make the best possible decisions during the next financial emergency.

A version of this column previously appeared on Federalism US. 

The post COVID-19 Pandemic Response Illustrates Need for Better State and Local Financial Data appeared first on Reason Foundation.

Without seasonal adjustments, the Census Bureau estimates 2020 aggregate state and local tax revenues of $1.62 trillion, or about 2 percent above the 2019 total of $1.59 trillion.

The Census Bureau also provides an aggregate state-only tax revenue estimate. State tax revenue was down about 1 percent in 2020: from $1.01 trillion in 2020 versus $1.11 trillion in 2019. In this case, increases in personal and corporate income tax receipts mostly offset a drop in sales tax revenue during the pandemic.

Results from the two series imply a slight increase in local government revenue, likely due to increased property tax receipts amid the strong residential property market.

The Census Bureau does not provide a specific local government-only tax revenue series.

More detailed Census revenue data (displayed in the below map) show that tax revenue performance varied greatly across states. Alaska and North Dakota, for example, suffered the two largest tax revenue drops due to lower energy prices. It is worth noting that these two states have accumulated large cash reserves that allow them to absorb the effects of price shocks. Also, energy prices have been rebounding in early 2021, suggesting that the revenue loss could be transient.

State Government Revenue Growth From 2019 to 2020

The only other state suffering a double-digit percentage revenue decline was Hawaii, which saw an understandably dramatic falloff in tourists and the tax revenues they generate. Nevada, another tourism-dependent state, ended the year down less than 3 percent.

Idaho registered the biggest increase in tax revenue from 2019 to 2020, gaining over 12 percent in 2020. Some of this increase is likely to stem from people temporarily, or permanently, relocating to the state in search of greater distancing than is possible in urban areas and/or in search of less onerous lockdowns than ones imposed by some states, including those on West Coast.

Despite out-migration and strong shelter-in-place restrictions, California registered a small revenue increase due to strong income tax collections. Many of California’s white-collar tech workers were able to work from and many businesses in the tech industry are thriving during the pandemic.

In the aggregate, the increase in state and local tax revenue further undermines the case for the large state and local aid package included in the most recent stimulus and relief bill, the American Rescue Plan Act, signed by President Biden in mid-March.

When it is over and taxpayers and lawmakers look back at the COVID-19 pandemic, it will be clear that states and local governments did not need a huge federal bailout in 2021.

While we’re continuing to see claims and headlines, such as, “With Federal Aid, Washington State Revenue Returns to Normal,” the fact is that state and local government revenues weathered the pandemic and have now received a large federal-taxpayer-funded windfall.

The post More Census Data Shows Government Tax Revenue Hasn’t Been Negatively Impacted By COVID-19 appeared first on Reason Foundation.

But since the massive federal spending bill has already been passed and signed, it would be wise for state and local governments to use this one-time revenue boost to reduce unfunded retiree health care obligations, which total $1.2 trillion nationally.

Because the new federal aid is not an ongoing revenue stream, using it to expand existing programs or start new ones would be imprudent fiscal policy and invite budgetary pressures down the road. Restrictions in the new law added by the Senate prohibit federal funds from being used to reduce taxes or pay down unfunded pension obligations. But the law does not explicitly mention other post-employment benefits, known in the government accounting world as OPEBs, which primarily take the form of health care coverage for retirees.

In some cases, state and local governments show net OPEB liabilities, which is the total amount of benefits already promised to retirees, as large or larger than their net pension liabilities. Although the total future cost of retiree health care benefits is smaller than pension benefits, which are intended to replace income, most governments have at least partially prefunded their pension benefits while setting aside little or no money to cover their future OPEB costs. This is often attributable to the strong legal protections granted to public pensions but that largely do not extend to OPEB benefit promises made to workers in most places. Nonetheless, by failing to set aside funds for retiree health benefits as employees accrue them, government employers are burdening future taxpayers with growing debt. The size of the problem is also raising doubts among prospective retirees about whether the benefits promised to them will really be there when they retire.

In this post, I consider two potential strategies for using the temporary increase in governments’ fiscal capacity to address unfunded other post-employment benefit liabilities: (1) prefunding and reforming defined retiree healthcare benefits, and (2) switching employees to defined contribution retiree health care benefits.

Option 1:  Prefund and Reform OPEBs

Many state and local governments currently finance OPEBs on a pay-as-you-go basis, meaning that they set aside no money while employees are working and then pay their health insurance premiums in retirement as the bills become due.

Under Government Accounting Standards Board (GASB) Statement Number 75, the present value of future OPEB costs (less any assets held to cover these costs) must be shown on a state or local government’s balance sheet. When that government uses a pay-as-you-go funding method, the future costs must be discounted at a “tax-exempt, high-quality municipal bond rate.” Some governments meet this definition by using The Bond Buyer 20 Index, which is the average yield for 20 general obligation municipal bonds with an average rating of AA from Standard & Poor’s and/or Aa2 from Moody’s. This index declined from 3.50 percent on June 30, 2019, to 2.21 percent on June 30, 2020, obliging many governments to report increased net OPEB liabilities for their most recent fiscal year.

But GASB Statement 75 allows governments to apply a higher discount rate “to the extent that the OPEB plan’s fiduciary net position is projected to be sufficient to make projected benefit payments and OPEB plan assets are expected to be invested using a strategy to achieve that return.”

This could be interpreted to mean that if a state or local government adopts a policy of paying its actuarially determined employer contribution each year, it can discount its future OPEB payments at the same rate it uses to discount pension obligations, typically around 7 percent (although the Reason Foundation and other pension reform advocates typically recommend more conservative discount rates).

A hypothetical case can demonstrate the significant balance sheet benefits of implementing an OPEB prefunding policy. Consider a public sector entity that expects to pay $100 million in retiree health caare benefits this year and for its costs to grow 6 percent each year, reaching almost $542 million in 30 years. Discounting this stream of benefits at a rate of 3 percent yields an OPEB liability of $4.55 billion. But, if we apply a 6 percent discount rate to the same set of annual costs, the liability shrinks to just $2.83 billion.

Now, before we continue, a caveat is in order. Many researchers and practitioners would argue that this balance sheet benefit is just an accounting trick. Their contention is that future benefits should be discounted at a rate based on the likelihood of the future benefits being paid rather than the expected rate of return on the assets being set aside to cover these costs. But irrespective of whether such a large balance sheet savings is theoretically justified, few would deny that prefunding benefits is both fiscally prudent and fairer to future taxpayers and retirees, many of whom will be our children and grandchildren.

That said, prefunding OPEB costs is a permanent commitment that lasts long beyond the 2024 deadline for using American Rescue Plan funds. Thus, OPEB prefunding will require an additional budgetary commitment from states in the near and intermediate-term (while saving money in the long-term as investment gains cover a portion of future retiree healthcare costs).

Given the increased short-run budgetary burden, state and local employers should also use any shift to pre-funding as an opportunity to reassess their OPEB packages. Retiree health care benefits were often initiated decades ago at a time when health care costs were much lower. Now that health care insurance premiums are so much higher, especially for retirees who have yet to reach the Medicare eligibility age of 65, benefit enhancements may require a second look. Among the items that should be reviewed are:

• The inclusion of spousal and dependent coverage;
• Whether dental and vision plan premiums should be covered along with medical premiums;
• Whether retiree health plans should incorporate such cost-saving elements as copayments, deductibles, and provider network limitations; and
• Whether to continue offering employer-paid life insurance plans (since this perk is not among those likely to promote employee retention).

Although public employees may not welcome skinnier retiree benefit packages, they would benefit from the fact that prefunding reduces the risk that their post-employment benefits will be suddenly canceled, as they were during the 2012 bankruptcy of the city of Stockton, California. Since OPEBs typically lack the legal protections afforded to pension benefits, employees should be willing to at least consider a tradeoff between the generosity of the OPEB package and the likelihood of ultimately receiving it.

Option 2: Replace Defined OPEBs with Retirement Health Care Savings Accounts

The prefunding approach leaves the Total OPEB Liability in place while increasingly offsetting it with assets. Another alternative is for public sector employers to replace their OPEB plans with defined contribution plans that provide comparable value to retirees.

Retirement health care savings accounts provide employees with 401(k)-like accounts to which both the employer and employees can contribute. Employee contributions and investment returns on the saved assets are not taxable until the account is used to pay healthcare premiums in retirement.

Governments could use some of the extra budgetary space created by the American Rescue Plan’s funding to make initial deposits into each employee’s health care savings account. They could then make smaller annual contributions each year until the employee retires. Although these annual deposits create a similar cost stream to prefunding a defined OPEB plan, they do not create a liability on the government’s balance sheet because there is no commitment to provide a specific level of benefits upon retirement.

Although a shift to retiree health savings accounts transfers risk to employees, it may actually offer a better benefit to shorter-tenured employees—who make up the bulk of people hired into public service today. These employees often do not stay with their government employers long enough to vest in the defined retiree health care benefits. But they could use their retiree health savings account balance at retirement, regardless of where they were last employed.

Conclusion

The two potential strategies outlined here are not necessarily exclusive. Retention of the defined retiree health care benefit with prefunding may be more appropriate for employees nearing retirement, while transitioning to retiree health savings accounts may be a better fit for more junior employees and new hires.

Either strategy, or a combination of the two, can set government employers on a path toward having zero net OPEB liabilities on their balance sheets at some point in the future. The removal of these unfunded obligations would be welcomed by credit rating agencies and municipal bond investors today and would provide a better fiscal legacy for taxpayers and employees tomorrow.

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