Chris Edwards of the Cato Institute testified at a Senate Finance Hearing on Tuesday.

Essentially, Edwards argued that the federal government has a "spending problem." Increased spending, he said, is almost entirely responsible for the last 5 years of high deficits. Therefore, we ought to get to the root of the problem and cut back on spending to get the deficit under contol. This is the same tack that Senate Budget Committee Chairman Judd Gregg (R-NH) has taken while advocating for drastic budget cuts.

There are a lot of things wrong with this line of reasoning, not the least of which is the canard that spending increases alone have caused the deficit. The Center on Budget and Policy Priorities has shown that the cost of the 2001 and 2003 tax cuts is three times the cost of all legislated spending increases. And revenues as a percentage of GDP are far lower than historical averages, suggesting that it's revenues that are out of whack, not spending.

Anyway, the most important thing that's wrong with this argument is that it doesn't matter what policies created the deficit. We don't have a "revenue" or a "spending" problem. What we really have is a deficit problem.

Mr. Edwards points out, correctly, that spending has gone up a great deal since 2001. Yet much of that spending increase has been for defense and homeland security. By Edwards's logic, if defense spending increases created a bigger deficit, we must cut back on defense spending. But nobody wants to do that just yet (including Mr. Edwards), because defense spending is a national priority.

The point is, the factors that caused the deficit tell us nothing about how to address it. We budget according to what our priorities are. We should decide how to address the budget deficit in similar fashion.

Senate Finance chair Charles Grassley (R-IA) is once again using reason to try to wrest the oft-deferred package of tax credit extensions from the smothering grip of the moribund trifecta (which also includes a massive estate tax cut, and a modest minimum wage hike).

Last week, he cited the high cost of printing IRS forms late as a reason to pass the extenders before FY 2007 starts on Oct. 1. This week he is pointing to a report that 19.2 million individuals would be affected by a similar delay in extending three of these credits -- state and local sales taxes, college tuition and fees, and teachers' purchase of school supplies:

The higher numbers are all the more reason to extend these tax breaks this week and not wait until the lame duck session. Waiting will create headaches and hardship for tens of millions of taxpayers.

And as noted in a recent Watcher article, Grassley's prediction that Democrats would score political points from the "do-nothing Congress" inaction on extenders is panning out.

Despite the putative costs to taxpayers and to GOP candidates -- and Grassley's appeal to reason -- there are no signs that the GOP leadership will bring the trifecta or any of its three component parts up for a vote in either chamber prior to pre-election adjournment this week.

According to a provacative new paper by Peter Francia and Renan Levine, Bush's policies have disproportionately benefited red states over blue states.

On average, red states get more money from the federal government than they give back in taxes, and blue states tend to give more money in taxes than they get back from the federal government. Now, socio-economic and demographic realities, for the most part, dictate where federal resources are going. The 10 poorest states in 2004 were red states, and 8 of the 10 richest states were blue states. But, in recent years, the income gap between red and blue states has been closing, even as the federal spending gap has widened. And this trend has continued under Bush.

When analyzing the change between 2000 and 2004, we find evidence in favor of the supporter benefits hypothesis. Even when controlling for all other independent variables, the model predicts that voting for President George W. Bush in 2000 increased the state’s level of net benefits by five cents from 2000 to 2004.

The paper's findings suggest that, in terms of fiscal policy, Bush supporters are in fact voting their pocketbook. The flow of federal dollars to red states may also explain why Bush's Social Security initiative failed. The paper concludes:

The implications of our analysis suggest that if the Republicans rolled back any significant programs, they would risk a backlash where they are strongest: in the poorest red states that receive the most benefits per tax dollar. As a result, the Republican Congress has left entitlement programs largely intact since coming to power in 1994. In the process, once Democratic programs now disproportionately benefit Republican states in the heartland.

Although today's Joint Economic Committee press release was intended to bemoan the absolutely crushing burden of income taxes paid by the top 50% of income earners which has stymied all attempts to get this economy moving [/sarcasm], it actually underscores a troubling trend in income distribution.

According to the new data, the top half of taxpayers ranked by income paid 96.70 percent of the individual income taxes paid in 2004, compared to 86.05 percent in 1949, 89.35 percent in 1959, and 90.27 percent in 1969.

One way to characterize these data is to say what committee chair Rep. Jim Saxon (R-NJ) says: "The new IRS data confirm once again that the tax burden is disproportionately borne by taxpayers in the top half.”

Another way to explain them is to point out the reason for the increasingly disproportionate share of income taxes: the top half of the income distribution is earning disproportionately more income.

Average tax rates for all the groups mentioned in the committee's press release (top 1%, 5%, 10%, 25%, 50%) have been consistently declining since 2001. So, the only way that their burdens of the share of income taxes would increase disproportionately is if their share of income increased disproportionately.

I'll let the charts do the talking.

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The Washington Post and the New York Times today have high-profile stories on how lawmakers and Administration officials have let corporations find ways around paying federal taxes and fees. Both are worth a look.

Washington Post: A Quiet Break for Corporations

New York Times: Suits Say U.S. Impeded Audits for Oil Leases

We've been posting recently about some of the bizarre and downright ridiculous things going on over at the Internal Revenue Service lately concerning enforcement of the country's tax laws (see this recent analysis for more background).

While these policy changes certainly deserve criticism, you have to tip your hat when things go right. Within two days last week, the IRS announced the two largest tax settlements in the agencies' history (one individual and one corporate) related to tax evasion.

In the individual case, the IRS settled its case against former telecommunications entrepreneur Walter Anderson. Apparently Anderson failed to pay over $200 million in taxes and did not report $365 million in income in 1998 and 1999. He further attempted to hide over $450 million in income from 1995 through 1999 in offshore companies and accounts. (hat tip: CAP BudgetBlog).

In the corporate case, the IRS settled its 16-year suit against British drugmaker GlaxoSmithKline in a "transfer pricing" scam where the company underreported its profits in the United States since 1989. From a Washington Post article:

At issue was one of the thorniest concerns facing tax collectors -- how multinational corporations apportion profits and expenses among units in different countries. The IRS has said that companies often manipulate cross-border transactions to minimize taxes...

...The IRS had alleged that Glaxo's parent company, GlaxoSmithKline PLC, based in Britain, had allotted too little of its profits from worldwide drug sales to its U.S. subsidiary. Determining the proper split in what are known as "transfer pricing" cases can involve apportioning such intangible items as the value of trademarks and brand names.

The company agreed to pay an unbelievable $3.4 billion to the IRS to settle the case - causing many private analysts and observers to conclude they were in very deep trouble. But no worries Glaxo stockholders - because they case dragged out so long, the company was able to build in the cost of the settlement over time and the payment will not have "any significant impact" on the company's earnings. Company shares rose 17 cents to $55.25 the day the settlement was announced.

Only $341.4 billion per year to go IRS, and the tax gap is closed. Keep it up!

Earlier, Matt posted about a GAO report released today about the unsustainability of the federal budget. The report illustrates in six pages the enormity of the challenges the federal budget faces. And it makes clear that even if Congress allows the 2001 and 2003 tax cuts to expire, as is currently the law, the federal government will have to make serious changes to its current fiscal policy. This fact is particularly relevant in light of the fact that Sen. Majority Leader Bill Frist (R-TN) has been desperately trying to push through Congress another $750 billion in tax cuts.

...under GAO’s optimistic simulation the fiscal gap would grow from 4.5 percent of the economy today to 5.7 percent in 2016 simply by waiting to act."

In other words, in order to simply maintain the current level of debt (relative to the size of the economy), the federal government would have to raise taxes or cut spending (or a combination of the two) by $600 billion today, and then maintain this level of revenue and spending (relative to the size of the economy) for the next 75 years. If the government procrastinates, as the current administration and Congress are wont to do, that number grows to $1 trillion (in today's dollars) in 2016.

Waiting longer, of course, means even more drastic changes.

...waiting until 2040 means that as a share of the economy, either taxes would need to be increased by almost 60 percent or total spending reduced by a third in order to balance the budget in that year. Sudden, drastic changes of either kind--and revenues at such a level--are outside post-World War II historical experience in this country. "

And, like every other report issued by the federal government - be it CBO, GAO, Treasury, or even the president's own budget - this document puts another nail into the supply-sider coffin.

Additional economic growth is critical and will help to ease the burden, but the projected fiscal gap is so great that it is unrealistic to expect we will grow our way out of the problem. To do so under any reasonable set of assumptions would require double-digit real economic growth for many decades to eliminate the long-term fiscal challenge. However, since the end of World War II we have not seen economic growth of this kind.

To bring some context to that statement: On average, the economy has grown 3.4% per year since WWII; at the eight of "dot com" boom of the roaring 90's, economic growth peaked at 4.4% per year.

The points here are that 1) we can make changes that will bring sustainability back to the federal budget and that 2) waiting to make these changes has very real consequences on the kinds of policy options available to us.

With time running out before adjournment and the House Republican Study Committee now openly urging that the tax credit extension component of the “trifecta” (HR 5970), be passed as a separate bill, GOP House and Senate congressional leadership is beginning to look desperate.

Yesterday, House Ways and Means Chair Bill Thomas (R-CA) floated the idea of adding a fourth piece to the trifecta that would stop the scheduled 5.1 percent cut in Medicare payments to physicians now set for Jan. 1.

In an issue brief, the Congressional Budget Office last week estimated the five-year cost of increasing physician payment rates by one percent in 2007 at $13 billion. At a five-year cost of $60 billion, this fix may not be what the doctor ordered.

Expect GOP leaders to “tri, tri” again.

Sen. Byron Dorgan (D-ND) introduced a bill today that would end the IRS privatization initiative. You can read Dorgan's press release here.

Also, the IRS appears to have gone forward with the initial phase of the privatization plan. This from the National Treasury Employees Union:

Despite the clear opposition in Congress to the plan, which includes a House-approved ban on the use of fiscal 2007 funding to pay for it, the IRS is moving ahead. The agency is believed to have assigned some 12,500 taxpayer files to three private debt collectors last Thursday—with plans to boost that number to 40,000 such cases by the end of this year.

The Senate ought to act quickly to keep the IRS from doing any more damage than it already has. And in case you're not sure why the Senate ought to, take a look at this column from the Center for American Progress.

Last week, you may remember that a group of oil companies announced that they discovered a huge new field in the Gulf of Mexico. The field is in federal territory, so the oil companies must take out a lease with the federal government and pay royalties on the oil they drill. Sounds fair, right? Well, despite record profits and high prices, the oil companies may get a massive break on royalties payments. Via Dean Baker, the NY Times has the story.

To keep you informed of IRS Commissioner Mark Everson's latest antics, we bring you this from American Public Media's Marketplace. Yesterday, they aired a great piece on the outsourcing of IRS collections. The nut of the story is this: The IRS wants to outsource the job of collecting outstanding taxes due and let the collection agency keep a percent of haul. Sounds great - the IRS gets some money it wouldn't have otherwise - the budget fares that much better. The rub? It's been done before and it ended up costing taxpayers $18 million when it was tried in 1996.

So why embark on a money-losing scheme?

KEVIN MCCORMALLY [of Kiplingers Magazine]: Congress will not give the IRS a dime to hire more employees. Because, no one's ever lost an election beating up on the IRS, so the IRS has been told to go out and hire private debt collectors, even though it's going to cost 20 to 25 cents on a dollar to collect these debts with the private people, versus maybe 3 to 5 cents on a dollar if they hired employees.

Marketplace: "Legislators keep rejecting, IRS keeps collecting"

My esteemed colleague and fellow BudgetBlogger Dana Chasin will be blogging on the estate tax over at TPM Cafe for the next few weeks. Check out his most recent post here!

Wall Street fatcats, beware! The Senate Finance and Banking Committees are watching you, and they're sick and tired of your greedy, cheatin' ways.

Seriously. They each called hearings today on executive compensation.

What these committees were upset about are rather (ahem) expansive interpretations of the 162(m) section of the tax code. Under 162(m), corporations can deduct up to $1 million in executive compensation from their tax returns. However, they can deduct more if compensation is "performance-based." This qualification created an enormous loophole, and helped executive compensation reach new heights in the late '90s. See this Slate article for more.

Harvard Law School Professor Lucien Bebchuk estimates that abuse of 162(m) has cost the Treasury at least $20 billion. The IRS has launched a "Corporate Executive Compliance" initiative in response. See here for more.

162(m) also encouraged corporations to offer stock options, which are automatically considered "performance-based". The Securities and Exchange Commission (SEC) is now investigating more than 100 corporations that "backdated" stock options in CEO compensation packages, thereby eliminating much of the risk (and performance-incentive) tied to stock options. The Wall Street Journal explains why better than I can:

Though backdating options isn't necessarily illegal, trouble can arise over such issues as disclosure, said Alan Dye, a securities attorney at Hogan & Hartson LLP in Washington. For instance, companies may report in proxy statements that the strike prices for options are always equal to the market value on the date of a grant -- generally when directors vote on the award -- but then choose a different date when the market value is lower.

That could constitute a securities-fraud violation for misleading disclosures, Mr. Dye said. Moreover, companies that engage in backdating may have violated accounting rules, by failing to include as an expense the extra compensation they gave employees in the form of discounted stock options, he said.

Almost everyone agrees that the SEC and IRS should crack down on fraud. The main points of contention here are whether to change the code, and how to do it. Should the code be better designed to discourage extravagant executive salaries? Should it just be clarified to encourage disclosure and tax compliance?

Interviewed in the WSJ (subscription), Senate Finance Chairman Sen. Chuck Grassley said that "the original purpose of the 1993 law [which created the "performance-based" clause] was to 'make sure that there wasn't a great deviation between what executives got paid and what people further down the ladder' got paid. 'It really hasn't worked at all,' Sen. Grassley said. 'I want to know what went wrong and how we can fix it.'"

And Sen. Grassley came to a similar conclusion in his closing statement at today's Finance Committee hearing.

I am a great believer in conducting oversight of the tax code and we need more of it from the press, GAO and the Inspector General. Clearly, we’ve learned today that 162(m) is broken.

Sen. Grassley says he wants reform that reduces inequality. We should hold him to that.

The 109th Congress reconvenes today for a last month of session (barring a lame-duck session) before a pre-election recess scheduled to start September 29. Among the many tax and budget issues that may see action this month, all three left over from the defeated “trifecta” bill -- which combined estate tax reduction, a minimum wage increase, and a tax extenders package -- are reportedly on the agenda. OMB Watch resumes its focus on these:

• Estate Tax -- Despite ambivalence from some GOP Senators worried about another loss on the issue and Congress’ do-nothing image, Majority Leader Frist is said to be poised “for one more battle” to make deep cuts in the estate tax. But would any Democratic votes switch from the last roll call on the issue on Aug. 3, when the GOP fell three votes short of the 60 needed to proceed to a motion to debate the trifecta bill?

  
  

• Tax Extenders -- Business lobbyists and others are agitating for the extension of a set of popular tax breaks -- including the research and development credit, college tuition deduction and the state and local income tax deduction -- which went down to defeat last month as part of the trifecta. But unless these breaks are de-coupled from the estate tax, they may need to wait until a lame-duck session. Alternatively, they could be added to an expected technical corrections bill for the recently-passed pension reform act.

  
  

• Minimum Wage -- The sticking point for Democrats who support a minimum wage hike was the provision in the trifecta bill that would lower the wages of employees in seven states where state laws require employers to pay the full minimum wage atop tips they earn. In a potential compromise, Republicans are said to be willing to tinker with the “tip credit” language to assuage those concerns and buy more votes.

Would the trifecta fare any better this time around? Can enough fixes and compromises be found to pass it? Is there even time for Frist to try it again this month? After last month's loss, can humpty dumpty ever be put back together?