Not by Income Tax Alone
Can we fix our budget problem by raising income taxes alone? With deficits as far as the eye can see, Rosanne Altshuler, Katie Lim, and I presented a paper at last week’s TPC/USC budget conference that came up with a fairly straight-forward answer: No.
We set a low bar for ourselves. Instead of trying to balance the budget, we aimed to cut the deficit to a sustainable 2 percent of GDP. And we wouldn’t even start to do the heavy lifting until 2015—to give the country time to regain its economic footing.
The Congressional Budget Office projects an average deficit over the 2015-2019 period of 3.2 percent of GDP under current law—that is, if the Bush tax cuts expire next year as scheduled and Congress stops patching the AMT. The average deficit jumps to 6 percent of GDP in the more likely event that Congress follows current policy and makes both the Bush tax cuts and AMT patches permanent as the president has proposed.
Katie used TPC’s tax model to simulate three income tax increases scaled to meet our deficit goals under both current law and current policy: raise all tax rates proportionally, raise just the top three income tax rates, or raise rates for taxpayers targeted by President Obama—couples with income over $250,000 and singles with income over $200,000. We also tried eliminating or limiting itemized deductions.
The results were discouraging, to say the least. Under the higher tax baseline of current law, we’d have to raise all individual rates by 15 percent to meet our 2 percent deficit goal. But under the lower-revenue scenario of current policy, rates would have to jump nearly 50 percent. In other words, the 10 percent bracket would become nearly 15 percent and the 35 percent top rate would go to 52 percent.
What if Congress just raised taxes for high-income taxpayers? Their rates would go up more than 40 percent under current law and more than 150 percent under current policy. In other words, the top tax rate would return to the bad old days of 90 percent. Even if we go for the Administration’s more modest goals—start with current policy and aim for deficits averaging 3 percent of GDP—those top tax rates would have to more than double, taking the top rate over 75 percent.
And our estimates ignore behavioral response. Research has shown that tax increases lead people, particularly at the top of the income distribution, to cut back their taxable income. While analysts disagree on the magnitude of that income shift, they’d all acknowledge that cranking the top rate up to 90 percent would lead to a massive reduction in taxable income and hence a lot less additional revenue than we found. People facing those high tax rates might work less or hire smart accountants. Either way, reaching our 2 percent deficit goal would require even higher tax rates and would quite likely prove impossible.
If we start with current law, we could also meet our goal by eliminating all itemized deductions, but that wouldn’t yield enough revenue under current policy. Besides, wiping out popular deductions for home mortgage interest, state and local taxes, charitable contributions, and other expenses would never fly. We even looked at capping the tax-reducing value of itemized deductions to 15 percent, but that wouldn’t raise nearly enough under either current law or current policy. (Last year, Obama proposed a more lenient 28 percent cap.)
Our simple exercise yields two important messages: We can’t balance the budget with income tax increases alone. We also have to cut spending and perhaps look for another revenue source as well. VAT, anyone?
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The Bottom Line blog made some cool interactive graphs out of this paper http://crfb.org/blogs/tpc-takes-tax-challenge-income-tax-rates.
Um, well yes. Because in your model you (conveniently?) neglected to include putting taxes on corporations, which have declined precipitously over the past two decades, back in balance.
Try running a model in which labor, profit and investment income are all taxed at equal rates, and see how that pencils out.
If you havent' figured this out by now, the idea that cutting revenue will result in drowning the government in the bathtub just hasn't worked. The best way to get a consensus for cutting spending is to charge the real cost of the programs in question. Only when people see what it really costs will they consider cuts.
The top 10% have about 90% of the discretionary income in this country. To point out that we in the top 10% pay 70% of taxes when we have 99% of the wealth is just so much hot air. The top 1% makes more money than the bottom 40%. The top .01% makes TWICE the bottom 20%; that's 30,000 in about 14,000 households making twice what 60,000,000 in 28,000,000 households make. Consider that data before you whine about “burden.”
When Rand wrote Atlas Shrugged the top 1% made about 8% of the pie, and were taxed at top rates over 90%. Now that the top 1% get 23% of the pie and are taxed at a top rate of 35%, it's time to stop thinking in terms of “blindly turning an eye to capital formation, productivity, …”
The fact is growth rates were higher then than they are now.
Partial Default? Anyone? Anyone? Bueller? Bueller?
I didn't suggest cutting foreign aid, as I don't labor under the false assumption that non-defense discretionary is the slush fund for balanced budgets.
To start, let's look at Medicare, it has a $38 trillion unfunded liability. What does that mean? That it's promises are richer than its means to finance them to the tune of $38 trillion. Seems like a good place to start. And don't tell me you can't do it — Dems mustered 60 votes to cut $500 billion from Medicare. Only problem was they wanted to turn around and spend the savings elsewhere (a health bill that increased spending and failed to bend the cost curve).
The top 10% pay 70% of the nation's taxes. I think as a society, we've all agreed to a progressive tax system as a fair way of distributing the needs to finance our government. That made sense when spending was at its historic norm of 20% of GDP. But when you assume a 24% or 25% of GDP level of spending, you can't just blithely assume that the upper income brackets can foot the bill (blindly turning an eye to capital formation, productivity and related wage increases) without real economic harm.
Suggest where. TANF and related programs and foreign aid are small potatoes. Whose ox would you gore?
Maybe, just maybe, you could cut spending? Anyone? Anyone? Buehler? Buehler?
I do favor a VAT, however to do it one must cut taxes at the low rates and provide a big sweetener to the poor so that they are held harmless.
Taxes will have to go up to both balance the budget and pay back the FICA surplus (which can't really be financed by increasing payroll taxes). Some form of payroll tax increase for Medicare does seem appropriate, however, since there is no appetite in the medical community for cost cutting.
An open question here is how much of the deficit is still bail-out spending. As some of the recovery assets are liquidated (even at a loss), some money does go back to the Treasury. Even with a loss, the bleeding here is not long term.
The big place to cut is, of course, the defense budget – particularly in the area of acquisition. We are fast approaching Norm Augustine's super plane that crowds everything else out. The other area where savings is possible is in ending the wars in Iraq and Afghanistan – although that can only be done through creative thinking, i.e., redrawing some of the boundaries to minimize the Taliban's area of support to Pashtunistan (including that portion now held by the Pakistanis). With Pakistani sovereignty out of the equation, we can either overrun the area or negotiate a peace.