The House Ways and Means Committee Republicans recently released legislation to retaliate against individuals and businesses based in countries that impose extraterritorial taxes on American companies. The proposal is a reaction to ongoing efforts by the OECD to coordinate a global tax increase on large multinational companies.

Instead of raising taxes, Congress should stop funding the OECD and focus on making the United States the most attractive place to do business.

The Republican proposal would have Treasury identify extraterritorial and discriminatory taxes levied by other countries on U.S. companies. Individuals and corporations based in the offending countries would then face higher tax rates on their U.S. income. The legislation specifically targets the OECD’s under‐​taxed profits rule (UTPR) and digital services taxes (DST). UTPR allows foreign countries to tax profits earned outside their borders if effective tax rates are lower than 15 percent. UTPR is one of five OECD-proposed rules that will enforce its proposed global minimum tax.

Biden Boxes Congress In

By working with the OECD to develop their Two‐​Pillar plan to increase global corporate taxes and then agreeing to the proposed outline for the new rules, the Administration has given Congress few options to reassert their legislative powers and protect American businesses from higher taxes. The Two‐​Pillar proposal is intended to more comprehensively tax the profits of multinational businesses by raising effective tax rates and reallocating taxing rights away from some countries and toward others.

The Ways and Means proposal is thus a predictable reaction to the Biden Administration using the OECD as an extra-legislative venue to advance policies that do not have congressional buy-in. The Administration has disregarded Congress’ constitutional tax-writing powers and unilaterally acquiesced to upending decades of international tax norms by giving other countries taxing rights to profits earned elsewhere.

The Republican proposal is a strong signal to other countries that the United States Congress is not ready to follow the Administration’s lead in outsourcing international tax rules to OECD bureaucrats in Paris. Sending this message is important, but Congress should focus on cutting taxes rather than raising them.

The tit-for-tat tax scheme concedes too much. The problem is more than UTPR and the possibility of new DSTs. The issue is the last two decades of OECD tax work to harmonize international tax law and end international tax competition. The OECD’s tax work no longer primarily coordinates tax systems to eliminate double taxation. Instead, it now proposes ever more complicated new tax systems and reporting requirements to raise taxes on multinational businesses. This is a recipe for increasing taxes, reducing tax competition to benefit high-tax governments, and reducing global investment by making international business operations more expensive.

Thanks to the OECD work, multinational businesses are now more likely to face higher effective tax rates, more tax uncertainty, and new forms of double taxation.

A Better Path

The OECD has proven it no longer serves the interests of the United States and has abandoned its founding mission to promote international economic growth. Therefore, Congress should stop financially supporting the OECD and reform our domestic tax laws.

First, Congress should follow through on the proposal of 10 House Republicans who asked the Appropriations Committee to prohibit any U.S. funding for the OECD in next year’s budget. The United States currently funds almost 20 percent of the organization’s budget.

Second, Congress should make America the most attractive place to do business in the world. The Tax Foundation ranks the United States 22nd out of 38 countries on international corporate tax competitiveness. Even after the 2017 tax cut, the United States still has an above-average corporate income tax rate, and key investment rules are in the process of expiring. Lowering or eliminating the corporate income tax and making full expensing for new U.S. investments permanent would both benefit American workers and undercut the OECD project. Congress could also increase financial privacy protections, prohibit the automatic exchange of taxpayer information with other countries, and cut the capital gains tax rate.

The most powerful message Congress could send is if it played the game the OECD is trying to stop. Making the United States an international tax haven would be a tit-for-tat game that benefits everyone.

Senate Finance Committee Chair Ron Wyden (D‑OR) held a hearing last week to counter the House Republican plan to cut the recent IRS enforcement boost. Sen. Wyden said, “If you’re looking for the big winners of the McCarthy IRS defunding plan, it’s billionaires and corporations who cheat on their taxes … Repealing that funding is a $191 billion giveaway to wealthy tax cheats.”

I offered a different view at the hearing. I noted that tax enforcement imposes collateral damage, that the tax gap has been stable for decades, and that the U.S. tax gap appears to be smaller than Europe’s. The “tax gap” means unpaid taxes from errors and cheating.

Here’s one problem with Sen. Wyden’s view: IRS audits find relatively smaller errors and cheating on higher-income returns than lower-income returns. As shown in the table below, IRS audits recommend additional tax of 5 to 8 percent of income for middle-income households, but just 1 to 4 percent of income for high-income households. These are averages within income groups over 2017 to 2021.

For example, for households facing additional tax, the average is $6,100 for those earning $75,000 to $100,000, which is 7.0 percent of income, and it is $117,033 for those earning $5 million to $10 million, which is 1.7 percent of income. Note that the average audit change of $117,033 for this high-income group may seem large, but that is just 6 percent of the average tax paid by these households. Also note that the large relative audit change in the bottom group mainly stems from errors and cheating on the earned income tax credit.

Why does the IRS find relatively smaller errors and cheating at the top? It may because these households are more likely to hire expert accountants and lawyers who have their reputations on the line. The relatively smaller errors at the top are impressive, given that high-income returns often involve complex issues such as business income and capital gains.

Data Notes. The IRS publishes aggregate results of audits in its annual Data Book. My table is based on a Government Accountability Office summary of the IRS data in GAO-22–104960 (p. 34).

The income groups are based on “total positive income” not adjusted gross income (AGI). However, the IRS and GAO do not appear to provide average total positive income within the income groups, so I roughly estimated it using average AGI for 2019 within AGI income groups.

A final note is that these are the additional taxes “recommended” by IRS auditors. But many taxpayers appeal these amounts and get them reduced. Also, some taxpayers challenge IRS audit results in court and many of them win, as discussed here.

The Inflation Reduction Act of 2022 boosted the Internal Revenue Service (IRS) budget over the coming decade by $79 billion, most of which is for increased enforcement. President Biden’s March budget includes the new spending and would more than triple enforcement outlays by 2031. House Republicans have proposed cutting the new IRS funding as part of the debt deal being negotiated.

At a Senate Finance Committee hearing last week, I argued that jacking up enforcement and auditing would cause collateral damage to the private sector. There are better ways to reduce taxpayer errors, including simplifying the code and overhauling IRS operations. Some analysts claim there is vast cheating by the wealthy and corporations, but the official IRS “tax gap” has not increased in decades relative to the size of the economy.

The IRS needs to audit at some level, but there is a balance. Higher audit rates would impose more costs on individuals and businesses in the form of time consumed, legal fees, anguish, and financial uncertainty. Another harm is that “audited firms are more likely to go out of business following the audit,” concluded one statistical study.

Policymakers should recognize that with such a complex tax code, it’s not just taxpayers who make mistakes. The IRS makes mistakes on calculations, sending notices, auditing, and other administrative and enforcement functions. In auditing, the IRS uses algorithms, discrepancies, and other factors to target returns. But the targeting gets more scattershot as audits increase, and so the collateral damage on taxpayers who have done nothing wrong rises rapidly as enforcement increases.

This effect is evident in the Government Accountability Office (GAO) chart below (from p. 13). At all income levels except the lowest, there were more IRS audits closed with no change in past years than today. That is partly or mainly because audit rates used to be higher, and the broader IRS dragnet encircled a larger share of taxpayers who had paid the correct amount. Today’s lower auditing rates may represent a better balance of costs and benefits.

By the way, note that higher-income taxpayers have higher “no change” rates from IRS audits. They appear to make fewer errors and cheat less than lower-income taxpayers.

A Congressional Budget Office (CBO) analysis of IRS enforcement finds, in parallel, that the marginal benefits to the government of enforcement falls as enforcement rises. The CBO estimated that adding $20 billion to enforcement would yield an additional $61 billion in tax revenues, but then adding a further $20 billion on top would yield just $42 billion in addition. These gains to the government should be considered alongside the costs of enforcement to the private sector and the general displacement of private activities as the government expands.

In sum, policymakers should remember that as audit rates rise, the share of taxpayers hit who are innocent increases, and also that the marginal revenue raised falls. A better way to boost compliance would be to improve IRS computer systems and taxpayer services, as promised in the agency’s strategic plan.

More on the IRS here, here, here, here, here, here, and here.

Data Note: The GAO says of the chart, “IRS officials explained that the no-change rate has generally decreased because as IRS does fewer audits, it tends to select returns for audit that have the highest chance of resulting in changes.” Thus, the more auditing, the more time and energies are wasted in auditing returns that are already correct.

The U.S. government teeters on the brink of defaulting on its payment obligations over the next few weeks as the debt limit threatens to bind in early June. There’s been extensive coverage about the potential for catastrophic impacts on the economy if Congress and the President do not raise the debt ceiling. What’s missing from the debate is serious consideration of the potentially catastrophic longer-term scenario the United States could face if spending and debt continue growing unabated.

Current debt limit discussions are indicative of the myopia that characterizes the federal budget process. A debt limit crisis presents a short-term legislative impasse of politicians’ own making. There’s an easy and certain way out of the immediate problem: increase the debt limit. A full-fledged fiscal crisis, however, is a much more uncertain, longer-term, and yet far more damaging scenario with no easy way out. And it becomes much more likely if legislators continue borrowing like there is no tomorrow.

The relevant question isn’t whether to raise the debt ceiling. Instead, the debt ceiling deadline should serve as an action-forcing event during which lawmakers halt the unsustainable growth in the debt.

As someone who cares deeply about the future of the United States and the well-being of current and future generations, I am frustrated by the misguided focus on short-term political considerations at the debt limit. Meanwhile, the longer-term debt crisis continues to unfold.

A study in the National Tax Journal, co-authored by Leonard E. Burman, Jeffrey Rohaly, Joseph Rosenberg, and Katherine C. Lim, lays out why a catastrophic U.S. debt crisis is a likely outcome of current fiscal policy and how it could play out. Below, I summarize their findings in the hopes that this will clarify why legislators and the public should be much more concerned about the prospects of a future U.S. debt crisis.

What are the risks of a U.S. debt crisis, and how could it affect the economy and individual Americans?

A U.S. debt crisis would have significant negative consequences for both the economy and individual Americans. A fiscal crisis could lead to a rapid increase in interest rates, inflation, and unemployment. This could trigger a recession and severely reduce economic growth. These modelled effects are based on observations of how debt crises played out in other countries. While there is no decisive threshold at which countries experience debt crises, as debt grows, the likelihood increases. Burman et al. write:

“Nearly one-fifth of countries that defaulted or required debt restructuring had external debt (held by foreigners) of less than 40 percent of GNP (Gross National Product), and more than half of countries experiencing debt crises had debt levels below 60 percent of GNP. Thus, 60 percent might be viewed as a rough barometer of high risk for budget failure. However, nearly one sixth of countries did not reach a crisis point until their debt level had exceeded 100 percent of GNP.”

At this time, foreign holdings make up about one-third of U.S. government publicly held debt. In case of a fiscal crisis, the government’s ability to respond would be limited. Below are some of the potential impacts.

Higher interest rates. A debt crisis could lead to a sudden increase in interest rates, which would make it more expensive for the government, consumers, and businesses to borrow money. This could slow down economic growth and potentially lead to a recession.

Decline in the value of the U.S. dollar. A debt crisis could also cause a decline in the value of the U.S. dollar, which could lead to inflation and reduce the purchasing power of Americans’ savings and investments.

Market volatility. A debt crisis could cause significant volatility in financial markets, which could lead to losses for investors and pension funds. This could also lead to a decline in consumer and business confidence, which could further reduce economic growth.

Steep and sudden cuts to government services. A debt crisis could constrain government services, forcing sudden and steep cuts to government programs with significant consequences for vulnerable Americans who rely on these programs for their livelihoods. Congress should reduce spending on these programs in a responsible way that allows affected individuals to find alternative sources of income, a possibility that could be precluded by a debt crisis.

Damage to the United States’ international standing. A debt crisis could damage the United States’ reputation as a stable and reliable borrower, which could make it more difficult for the government to borrow in the future and undermine the current standing of the U.S. dollar as a global reserve currency.

Why might a U.S. debt crisis come on suddenly instead of building over time?

Burman et al. contrast rising debt leading to higher interest rates, which could be a disciplining force for Congress, with debt accumulation as interest rates stay low, which could encourage further fiscal profligacy until gradual corrections are no longer possible. They write:

“A far worse situation would be for interest rates to stay low while we accumulate unprecedented amounts of debt only to respond very suddenly when financial markets or foreign lenders decide that the United States is no longer a good credit risk. That could produce a catastrophic financial meltdown, like the Great Recession, which was triggered by the housing bubble bursting, but with one crucial difference. If the crisis is caused by an excessive amount of government debt, the government will not be able to borrow to deal with its effects. This would be a catastrophic budget failure.”

Like recent banking crises, a U.S. debt crisis could arise suddenly because of how financial markets respond to revised information and changing economic and political conditions. Certain economic models, such as herd models and winner-take-all models, suggest that when investors suddenly doubt the government’s ability to pay back its debts, they may rush to sell U.S. bonds all at once. Such a sudden surge in sales could lead to a rapid rise in interest rates, making it more expensive for the government to borrow and potentially triggering a broader financial panic.

If government bond markets represent a winner-take-all scenario, Treasury bonds could be trading at lower interest rates than they arguably should, given U.S. government debt accumulation, until such time that another country’s bonds take the first spot. According to Burman et al.:

“The safest asset, currently U.S. government securities, can secure an almost limitless supply of cheap capital, while the next most safe asset trades at a substantial risk premium. Volatility in world markets, even if it makes Treasury bonds less safe, raises the risk premium even more — increasing the flow of capital to the United States and further depressing interest rates. This would explain why Treasury yields plummeted even as the U.S. financial sector was teetering on the brink of collapse and the economy was heading into a deep recession, and it would be consistent with the further decline in U.S. interest rates when Greece and other Euro-zone countries experienced debt crises.”

In a winner-take-all scenario, the United States government could continue to borrow at low rates for as long as there is no suitable competitor to take the spot of the U.S. dollar as the world’s preferred reserve currency. Betting on the permanency of U.S. Treasury bonds being considered the safest, global dollar-denominated asset, besides cash, could be a very risky bet over the long run. As the American Enterprise Institute’s Michael Strain so aptly wrote: “the absence of a better alternative is a thin reed for national greatness and global economic and political leadership.”

Herd models suggest that a fiscal crisis can arise suddenly because investors’ behavior is driven less by the underlying economic fundamentals, and more by the actions of other investors in the market. If a fiscal crisis triggered a Treasury sale-off, the first investors to sell off their holdings reap significant rewards, while those who hold onto their investments could face steep losses. This creates a powerful incentive for investors to act quickly and follow one another in a panic, potentially leading to a self-reinforcing cycle of selling bonds and increasing interest rates. The sheer size of the U.S. debt, which is approaching the country’s gross domestic product, makes the federal government’s ability to borrow vulnerable to sudden shifts in investor sentiment and changing market conditions.

What steps can policymakers take to address the root causes of our fiscal imbalance and reduce the risk of a sudden fiscal crisis?

Instead of the false dichotomy being presented by the Biden administration of raising the debt limit without conditions as the only way to stave off a crisis, the responsible choice is to adopt fiscal reforms that slow the growth in future debt when increasing the debt limit. The United States debt is highly unsustainable, growing faster than the economy toward all-time-record levels. The primary driver of our long-term fiscal imbalance is entitlement spending on programs like Social Security, Medicare, and Medicaid. Any serious reform proposal must reduce spending on these programs.

Congress should consider a Better Budget Control Act to save at least $8 trillion through a combination of new limits on discretionary spending, immediate reductions to mandatory spending, and future savings from reforms to Medicare and Social Security put forth by an independent commission. Such an agreement would allow Congress to responsibly raise the dollar‐​denominated debt limit without further inflating the public debt as a share of the economy. Taking steps to prevent a future fiscal crisis won’t be politically easy, but it’s necessary.

The Federal Bureau of Investigation (FBI) is in the news with the release of the Durham report and this week’s testimony in the House about the agency’s politicized leadership. In response to the FBI’s recent failures, many columnists and policymakers have called for either reforms, funding cuts, or agency dismantling.

The FBI has an annual budget of more than $11 billion and a workforce of 37,000 spread across headquarters, 56 field offices, 350 satellite offices, and dozens of foreign offices.

The chart shows that real FBI spending almost doubled from $5.25 billion 2000 to $10.44 billion in 2011 and has since trended slowly upwards reaching $11.4 billion in 2023.

I recently testified for the Senate Budget Committee on the topic of taxes, economic growth, and budget deficits.

You can read my full written testimony here, and watch the hearing here. Below is a lightly edited version of the three main points I emphasized in my oral remarks.

First, the 2017 Tax Cuts and Jobs Act was a success. Second, tax cuts did not cause the federal deficit. And third, the topic of this hearing is really about the appropriate size and scope of government—a topic on which reasonable people can disagree. However, if Congress decides that the current trajectory of federal spending does not need to be curtailed, it should be honest with the American people. Big government is expensive, and it will require significantly higher taxes on everyone.

I’ll begin with a bit of history of the 2017 tax cuts. After years of misleading reporting, many Americans still don’t believe that they benefited from a tax cut. This is a shame because the law not only lowered taxes for Americans at every income level, it simplified taxpaying, and supported an economy that was struggling to finish the long climb out of the great recession.

The law cut taxes for more than 80 percent of Americans and cut the tax bill for the lowest-income Americans the most. Despite claims to the contrary, the Tax Cuts and Jobs Act made the U.S. tax code more progressive—collecting a larger share of tax revenue from the highest-earning taxpayers.

The law cut tax rates for individuals, doubled the child tax credit, and curtailed special interest itemized deductions so that 30 million more taxpayers now used the simpler and larger standard deduction.

The tax cuts also boosted wages, investment, and economic growth by expanding full expensing for businesses and lowering the corporate tax rate to 21 percent—moving us from one of the highest rates in the developed world to a bit above average. In 2018, investment outpaced CBO projections, new manufacturer orders increased, and small business optimism peaked.

The labor market also improved. Wage growth went from flat or declining, to steadily increasing. At the beginning of 2020, the average production and nonsupervisory worker saw about $1,400 in higher wages. These economic gains were also widely shared. Following the tax cuts, inequality declined as income growth among lower-income and minority households outpaced all others.

Second, the deficit is the result of unsustainable spending growth, not a lack of tax revenue.

Last year, federal revenue was at a two-decade high, and this year’s revenue as a share of the economy will be a full percentage point above the historical average. If the Treasury collected as much revenue as it did when we had a budget surplus in 2000, the current deficit would still be above five percent of GDP.

It’s new spending that drives the deficit. For example, President Biden has added about $5 trillion in unnecessary spending to the national debt. That’s more than three times the 10-year revenue reduction of the 2017 tax cuts.

Deficits are caused by spending more than Congress is willing to raise in taxes.

Which brings me to my final point. Americans benefit from being a relatively low-tax country, compared to many others around the world.

A lower-income taxpayer will pay about $6,000 more in taxes if they move to Europe. A middle-class taxpayer would fork over more than half of his income and pay about $16,000 more in taxes.

President Biden’s pledge to increase government spending without raising taxes on Americans earning less than $400,000 is a mathematical fiction. Every other large modern welfare state funds its programs with high taxes on the poor and middle class. Advocates of more government spending need to be honest with the American people. Big government requires significantly higher taxes on everyone, not just the rich.

Tax increases are also no panacea. Historically, higher taxes prolong and deepen recessions, fuel higher spending, and don’t lower government debt ratios. Keeping government small is the best way to ensure the American people can continue to prosper.

Without addressing spending growth, ever-larger tax increases mean the poor will get poorer, and deficits will get bigger.

Instead, I hope that Congress addresses the drivers of our unsustainable budget, puts constraints on the size and scope of government, and protects Americans from the costs of higher taxes as the 2017 tax cuts begin to expire.

Given the steep population decline Puerto Rico has experienced, policymakers should reconsider whether remaining residents can continue to support 78 separate municipios. Consolidating some of these governments could result in more efficient service provision and reduced administrative overhead.

Puerto Rico’s population has declined 15% since the 2000 Census, but the rate of population change has varied widely across municipios. Seven municipios registered population increases between 2000 and 2021, while twenty suffered declines of 20% or more.

Smaller municipios that have experienced proportionally large population declines are especially prone to service insolvency, a condition under which the government continues to pay its bills but lacks the ability to provide public services at the level residents might reasonably expect.

The municipio that suffered the largest population decline since 2000 is Guánica—on the island’s southern coast, 45km west of the city of Ponce. Its 2022 population of 12,800 is down 41.5% since the century began. Aside from the challenges faced by other southern coastal communities hard hit by hurricanes and earthquakes in recent years, Guánica is also struggling with chemical contamination in and around its bay.

The municipal government appears to lack the capacity to provide adequate public services under these difficult conditions. According to its latest available federal Single Audit, 65% of Guánica’s spending was devoted to general administration, dwarfing the amounts spent on public safety, public works, and health and welfare, which together accounted for only 10% of total spending.

The Single Audit for the fiscal year ended June 30, 2020, shows that Guánica is heavily indebted and in fiscal distress. Long-term liabilities amounted to over $1100 per resident, and the muncipio’s general fund has a negative balance. Guánica’s balance sheet is likely worse than reported because damage to Guánica ‘s capital assets from hurricanes and earthquakes had not been assessed. This issue caused Guánica’s auditor to issue a “adverse” opinion, meaning that its financial statements cannot be relied upon to determine the municipio’s true financial condition. The fact that Guánica’s fiscal year 2021 financial statements are not yet available is another indication of its financial challenges.

With all that in mind, it is worth noting that Guánica and other struggling municipios may show better financial results in fiscal year 2022 due to the American Rescue Plan Act, which provided $1.5 billion in aid to Puerto Rico’s local governments. But that is a one-time windfall that cannot resolve long-term financial issues.

Although Puerto Rico’s Financial Oversight and Management Board (FOMB) has noted issues with municipio performance, it has stopped short of advocating consolidation. In a recent essay, FOMB Research Director Arnaldo Cruz identified a variety of problems afflicting municipal governments, including failure to meet budgetary revenue targets, borrowing to cover operational expenses, inability to complete capital projects, and procurement irregularities.

Cruz recommended regionalizing individual government services. For example, several municipios could participate in one regional authority that would provide public works services. These regional service providers would be similar to the Joint Powers Authorities that operate in California and some other states.

Although regional service providers could reduce municipal expenditures through economies of scale, they would not address the administrative bureaucracy that manages each municipio. It is only through full consolidation that redundant mayors, municipal legislatures, and support staff can be addressed.

Another challenge to regionalization of the kind recommended by the Oversight Board is lack of take-up. In 2020, the Oversight Board announced a Municipal Consolidation Fund for the purpose of providing one-time grants to municipios that voluntarily participate in service consolidations. But, according to a recent Commonwealth fiscal plan, the Oversight Board’s Municipal Consolidation Fund had yet to make any grants as of April 2023, despite the Board earmarking $22 million annually for this fund.

From a political standpoint, combining municipio governments is undoubtedly a heavy lift. Mayors, municipal legislators, staff, and suppliers all have an interest in protecting existing bureaucracies and know how to affect the policy debate. Regular Puerto Rico citizens and federal taxpayers who bear the costs of duplicative government structures, individually, pay too little for this inefficiency to be a salient issue. If Puerto Rico is to gain the benefits of municipal consolidation, good government advocates will have to push the idea forward.