Why Taxes Are Going Up
It’s hard to imagine that spending restraint alone can solve America’s long-run fiscal woes. Facing an aging population and rising health care costs, the federal government will continue to expand even if policymakers take serious steps to trim spending. That’s why policy wonks are working so hard to evaluate ways to raise more revenue. Cutting back on loopholes and other tax expenditures, taxing carbon emissions, introducing a value-added tax – all of these deserve attention in case America decides that it wants to finance a substantially larger federal government.
However, that focus sometimes overshadows a key fact about our tax system: Revenues are already on track to rise substantially in coming years. And not just because of an economic rebound and expiring tax cuts. There are structural reasons why tax revenues will grow faster than the economy.
The Congressional Budget Office estimates that tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 if current law remains in place (the “extended baseline” scenario in pink):
To put those figures in context, note that federal revenues have averaged about 18.2% of GDP over the past forty years. Tax revenues today are thus remarkably low. Indeed, they are the lowest they’ve been since 1950. But that will quickly reverse under existing law. By 2020, revenues would near their all-time record (20.9% of GDP in 1944) and by 2035, revenues would be more than 25% higher than historical levels.
That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.
Together, those six factors will increase tax revenues by 8.4 percentage points of GDP over the next 25 years, according to CBO. About a third of that increase (2.7 percentage points) comes from expiring individual income tax provisions and the expansion of the AMT. Another third (2.6 percentage points) is due to real bracket creep and reduced credits. And about one-seventh (1.2 percentage points) results from the tax increases in the health legislation. The other factors account for the remainder.
We clearly have sizeable tax increases built into our revenue system. The trillion-dollar question, however, is whether policymakers will allow them to happen. That’s why CBO considers a second scenario in which Congress gives in to the temptation to cut taxes. Under that “alternative fiscal” scenario (blue), Congress would permanently extend most of the 2001 and 2003 tax cuts and would limit the growth of the AMT. That would slow the growth of tax revenues but they would still reach 19.3% of GDP by the end of the decade, well above the forty-year average. CBO assumes that policymakers would then enact a series of unspecified future tax cuts to hold revenues at that level rather than letting structural factors lift them higher.
CBO’s bottom line is thus simple: tax revenues will rise faster than the economy even if Congress does nothing new. Indeed, revenues may rise faster than the economy even if Congress enacts substantial tax cuts. Our long-run fiscal dilemma exists because the scheduled growth in future spending is even larger than the scheduled growth in future revenues.
Michael, I don't see that. from the trough in 1982 to the peak in 1989, real tax revenues increased, in 1980 dollars, from 527 B to 655 B. From the trough in 1991 to the peak in 2000, real tax revenues increased from 636 B to 965 B, and from the trough in 2001 to the peak in 2007 real tax revenues increase from 922 to 1017.
When you divide out inflation, this is not the case.
Yo Yo, I don't think that your reasoning holds up. You can no more compare the tax revenues of 2008 (the peak of a business cylce) to the revenues of 2001 (the trough of a business cycle) than you can compare the tax revenues of 1993 (trough of a business cycle) to 2000 (peak of a business cycle). Revenues have less to do with tax rates than they do with where in the business cycle we are. This is the typical ruse that repubs like to take as gospel, that the 7 fat years of the Reagan era were the result of lowered tax rates when really all they were the result of was year 1 being the trough of a brutal recession and year 7 being the peak. It is odd, but not surprising that the Democrats can't seem to do the same branding with the Clinton miracle of tax revenues in 2000.
This post is so flawed it's hard to know where to begin.
First, the post implies the Bush tax cuts brought about lower tax revenues. Nothing is further from the truth. Income tax receipts were significantly higher in 2008 than in 2001.
The flawed reasoning continues – no need to enumerate them here. Suffice it to say that Marron may be exactly right about the endgame, but for precisely the wrong reasons. If taxes rise across all the categories as he anticipates, US GDP will be so weak that tax revenues will be simply be taking a larger share of our anemic national income.
Let's do what JFK did – lower marginal rates and unleash our economic engine. We will easily generate the tax revenues needed to support our economy, and likewise reach a tax/gdp ratio of 18%.
So the picture is pretty clear — we're going to need both tax increases and spending reductions (unless of course we get much more serious about reforming health care in order to deal with the pending disasters in Medicare and Medicaid, and much more serious about doing foreign policy through diplomacy rather than costly and alienating wars . . .).
There's still a political problem here. I'll put it in terms of my own experience which is fairly typical of a lot of the younger to medium-aged people who supported Obama in '08. Put it simply, I am facing $12,000 in additional interest charges on my student loans over the next 30 years because of the way the Democrats handled the abolition of private loans. The on-time payment incentives the privates offered — this is how they used a large chunk of their public subsidy — have gone away, just in time for completing my postgraduate study, because every last cent was swept up for Pell Grants without regard for the very real education debt burden of those who are in-school or already graduated. And I'm looking at something like $1,500 to $2,000 a year in extra taxes if at least the middle class portion of the Bush cuts is not renewed. Not to mention the huge passport fee increase and other little barbs and chastisements. And then there's Obama's deficit reduction commission, stacked to the gills with opponents of Social Security, threatening to cost me a key part of my retirement due to their misguided focus on Social Security rather than Medicare as the main financial threat to the system. And yet there's no talk of reversing the Republicans' irresponsible 1997 investment tax cuts that drove the tech bubble, the only member of the administration seriously talking about defense cuts is the leading Republican Bob Gates, and the Dems balked at the more far-reaching health reform options that would have saved the taxpayer and health-premium-payers alike real money by cracking down more aggressively on profiteering and waste and introducing more competition.
So, this former core Democrat, now independent voter is facing a big extra expense and insecure retirement due to the fact that a Democratic president elected on a strong reform mandate and with the benefit of probably the strongest House Speaker in two generations has failed to show leadership on the fiscal matters that count. Pelosi served up the possibilities to Obama on a platter, but he squandered so many of them, ordering Harry Reid to try to find “bipartisanship” where there isn't any — and here's where we are. Staring down the tunnel at the biggest middle class tax increase in history and historic cuts in retirement benefits while the ballooning health care industry and other special interests go on feeding at the public trough and foreign wars go on unabated and weakening America's reputation and political capital abroad.
I'll gladly try to help Pelosi preserve her House majority, but I'm to the point where I'll seriously consider directing my 2012 presidential vote elsewhere unless the Republicans nominate someone who is completely irresponsible. Of course there's the rub. Several of the leading prospective Republican candidates are certifiable. Nonetheless, Obama had better snap out of his pandering to the Establishment if he's interested in avoiding mass abstention. The audience for “change” is not as captive as he seems to think.
The baseline growth for federal expedintures: do you assume that health care costs will continue to increase by pre-reform estimates? Long-term expenditures are dominated by the trend-line of health care cost inflation.
The Ryan plan is an impossible dream, since it relies on personal accounts for Social Security and senior health care to make its numbers. Passage of such non-sense is a Herculean assumption, given the number and lifespan of the baby boomers over the next 30 years.
There is a set of numbers between the Extended Baseline and the Alternative Fiscal, where tax cuts for the wealthy expire, but not for the middle class and the poor. Tax issues have been allowed to remain unsettled to pass health care reform – however they will eventually shake out. This all depends, of course, whether the Speaker of the House changes her mind about passing a budget and including Reconciliation instructions. Without such instructions, the Democrats must find 60 votes for a tax reform bill that funds the tax cuts the President wants while allowing the others to expire. I fear she is playing a high stakes game of chicken here – both on the fillibuster and the tax cuts. If she is not careful, the kind of blanket tax cut extension the President does not want will pass – and allowing the savings sector these breaks will not improve the economy. Indeed, it will do the opposite. Money needs to go to consumption, not speculation, for the economy to evenutally improve. Businesses hire when sales go up, not when taxes go down. Indeed, small businesses may hire in the face of higher taxes on the owners if expansion is the only way to maintain their personal income levels.
>That’s why CBO considers a second scenario in which Congress gives in to the temptation to cut taxes.
Donald, you should have made clear whether the loaded phrase “temptation to cut taxes” originated with CBO, with you, or with CBPP or some other source. As the article is written, it appears to attribute this political slant to the CBO. I doubt they would like that, unless it's accurate.
Even the choice of current law as a baseline carries a political slant, which is why the CBO and the Obama administration also show a current policy baseline.
Current law is a fantasy world and everyone has known it since the 2001 tax cut sunsets were enacted. To pretend that current law is not only realistic but the only valid baseline is beyond fantasy, in my opinion. It's politically motivated wishful thinking of the sort that that CBO would not be caught dead indulging in. CBPP does it every day, but they have a clear agenda. The Tax Policy Center ought to steer a middle course, matching or exceeding CBO's record of non-partisanship and freedom from ideology.
I'll add one more point about baselines. In logic, there's a method called Proof by Contradiction. You assume X and show after a number of logical steps that it leads to not X, a contradiction of the original premise. This proves that X cannot be true in the first place.
I submit that the same technique can be applied to fiscal baselines. If the baseline is not sustainable, it is not valid. Period. It must change, so it cannot be called a baseline.
We currently have no valid baseline. Nothing short of the Ryan plan, which is merely a budget summary without policies to fit, meets this criterion. Until a sustainable baseline exists, we are better off forgetting about the entire concept of baselines.