Where Will New Revenues for Deficit Reduction Come From?

By :: February 17th, 2011

 If Washington is going to need new tax revenues to bring the deficit under control—which it inevitably will-- I increasingly wonder where the cash is going to come from. If you listen to what President Obama has been saying in recent days, it appears that while corporations and nearly all individuals and families would avoid any tax hit at all, a handful of high-income households would get socked with major increases.

These tax hikes would be so big, in fact, that top-bracket taxpayers might end up paying a rate of 67 percent on ordinary income and nearly 50 percent on capital gains.    

Since proposing his 2012 budget, the president has laid out three goals: He wants to reform the corporate income tax, but in a way that raises no more money than the current code.  He’s repeated his long-standing vow to never raise taxes on individuals making $200,000 or less (or couples up to $250,000). Thus, he’d exempt 96.5 percent of households from any tax hikes. And despite those self-imposed constraints, he also wants to dramatically reduce the long-term deficit.

As a result, a relative handful of individuals and families (fewer than 6 million) would foot the entire revenue bill for deficit reduction. The pain of spending cuts would be distributed very differently, of course.   

How big would these tax hikes have to be? To find out, my Tax Policy Center colleague Rachel Johnson crunched some rough numbers.  Although Obama has never quite set a specific deficit reduction target, let’s assume his goal is fiscal balance. And let’s say Obama would get there with the same formula as his fiscal commission—two-thirds of deficit reduction from spending cuts and one-third from taxes.

To reach balance in 2020, Obama would have to reduce the deficit by $735 billion in that year alone. Using the two-thirds/one-third formula, the tax hike would be about $245 billion.  

Also, keep in mind that to get the deficit down to $735 billion, Obama is already assuming the Bush era  tax cuts expire after next year for high earners and new taxes in the health law kick in. That means those folks will already be paying a top tax rate of 39.6 percent on ordinary income as well as higher rates on capital gains and dividends.  Even after that, the top 3.5 percent of earners would be hit with an additional average annual tax hike of more than $42,000.

These folks are doing quite well, thank you, making an average of well over a half a million dollars a year after taxes. And they’ve been big beneficiaries of tax cuts over the past decade. Still, their incomes would fall by 7 percent, on top of the cut in incomes of 2.5 percent to 4 percent they’d face with the expiration of the 2001 and 2003 tax cuts.  

If they had to pay just through higher rates, the top bracket on ordinary income would rise to more than 67 percent and the rate on gains would approach 50 percent. Note to president: This isn’t going to happen.

Among the oddities of this policy: While corporations would, on average, pay no more in tax than they do today, nearly one million successful businesses  that report their income on individual tax returns would get clobbered.  But rather than writing a bigger check to the IRS, many firms would simply reorganize themselves as corporations, especially if Congress also slashed the corporate rate below today’s 35 percent.     

Perhaps budget balance isn’t really the goal for Obama and Congress. Maybe they’ll  be happy with a long-term deficit of 3 percent of Gross Domestic Product--a level many economists believe is sustainable since the debt would be growing no faster than the economy. Or perhaps some future budget deal will rely even more heavily on spending cuts (though that seems pretty unlikely as long as Democrats have some say in the matter).  In those cases, the burden on high-earners may be eased.

But if Obama and Congress are serious about balancing the budget, they are not going to get there by squeezing tax revenues from just a small sliver of households.

23Comments

  1. Sid F.  ::  7:21 pm on February 17th, 2011:

    Analysis of increasing taxes to reduce the deficit are exercises in futility. Politically, it is just not going to happen.

    What you are seeing is the opening salvo in a battle to define the role of the federal government in American society. Conservatives want this to be about 14-15% of GDP. Moderates and Progressive see the number at 20-22%, more during recessions when fiscal stimulus is needed and government programs are needed to ameliorate the suffering by those who are the victims of recession.

    Since Conservatives want to balance the budget at the current level of revenues, no tax increase can be passed by the Congress, which is now and for the foreseeable future controlled by Conservatives. Furthermore, tax neutral legislation cannot pass because it would raise taxes on some groups, which is also a political impossibility.

    Over the next decade the U. S. will either be a modern state with an effective federal government spending an average of 22% or more of GDP or it will evolve into a group of regional entities, still operating under a common nationality for defense, Federal Treasury, Justice, Health Care, and Retirement programs, but with the rest controlled by states and regions.

    To quote someone else, if something cannot continue, it will not continue. The status quo cannot continue, and so it won’t, but the idea that tax increases are politically possible is a concept that cannot be conceived.

  2. Secondary Sources: Deficit Reduction, Unemployment, Models and Risk – Real Time Economics – WSJ  ::  9:06 am on February 18th, 2011:

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  4. The American Spectator : AmSpecBlog : The Limits of Revenue-Side Solutions to the Deficit Problem  ::  1:06 pm on February 18th, 2011:

    […] into the few hints President Obama has provided regarding his plan for reducing the deficit, and crunches the numbers. Gleckman assumes, as Obama has stated since proposing the 2012 budget, that he wants to close the […]

  5. AMT buff  ::  5:12 pm on February 18th, 2011:

    Balancing the budget solely on the backs of “rich” is as realistic as balancing it by cutting “waste, fraud, and abuse”. Politicians who try to sell these lines are lying.

  6. Conan776  ::  5:31 pm on February 18th, 2011:

    Why? Taxing the rich was how the government paid for things for most of the 20th century.

  7. Conan776  ::  5:33 pm on February 18th, 2011:

    Congress will be controlled by conservatives for the “foreseeable future”? You can’t foresee elections in 2012?

  8. Sid F.  ::  6:51 pm on February 18th, 2011:

    Conan is correct in that no one can foresee elections in 2012, much less beyond. However, in recommending and analyzing policy positions one must make reasonable assumptions about what the political landscape will look like. Otherwise one is wasting time talking about sane, rational, reasonable policy decisions that have no chance of ever being implemented.

    Obama has neatly fallen into the tax trap. Parts of the so-called compromise expire at the end of 2011. If provisions, such as the temporary payroll tax holiday are allowed to lapse, Obama will be accused of raising taxes on working men and women. If they are continued, he will be blamed for $1.5+ trillion in annual budget deficits. He may win, but only because the Republican candidate whoever he or she is is viewed more unfavorably because of extreme views.

    In the United States Senate there are 10 Republican seats in the election in 2012, and 23 Democratic seats. Those who list things like the “10 most vulnerable seats” show only Scott Brown and John Ensign in that group, and many Democrats in Massachusetts have conceded the race to Brown. Ensign is unlikely to survive a primary challenge, if there is one. Democrats are retiring in four Senate seats for 2012. The only real question is how large the Republican majority will be in the Senate after 2012, and since the math is similar in 2014, and since incumbent party’s Congressional candidates do their worse in the sixth year of a President second term, (assuming Obama is re-elected, if not Conservatives will control all three branches of government) the only question for 2014 is whether or not the Republicans will reach a 60 seat majority.

    In the House, re-apportionate and re-districting alone should add 15 to 25 seats or more to the Republican majority and Democrats in the House face the same problem in 2014 as described above.

    The South is almost solidly Republican at the state levels. Republicans control the legislatures of key Democratic states like Wisconsin, Ohio, Indiana and Michigan, and it is hard to see Illinois staying Democratic after the tax increases. The midwest farm states have become solidly Republican. Texas is a prime example of the Democratic problem. It is the fastest growing state, including a huge growth of Latino’s, yet the Democratic party is fall all purposes irrelevant in the state.

    Money will never again be a limiting factor for Conservatives. The major support for the Democratic party is public employee unions, and its not hard to see where they are headed.

    The Democratic strategy seems to be to hope for Republican overreach and for scandals, something that may happen. That is about the same quality of a strategy as a football team hoping to win because the other team fumbles, drops passes and has a lot of penalties. It can happen, but I would not base policy and analysis on it. In fact, Conservatives may well take over complete control of government by default.

  9. CLARENCE SWINNEY  ::  7:45 pm on February 18th, 2011:

    WOW! YOU ARE SCARY. BUT FACTUAL.
    The PERSON will get Wall Street Money for Republicans in 2010.

  10. CLARENCE SWINNEY  ::  7:58 pm on February 18th, 2011:

    2009 Federal Government took 17.5% of Total Income.
    Fortune 400 paid 18% in Tax.
    S&P 500 Largest corp–over 200 paid zero tax.
    70 got a refund. Sonme with revnue in billions.
    Exxon got refund in 2007.

    Must tsx rich and corp. $$$ there.
    1% get 24% Total Income
    1% own 50% Total Net Worth.

    Flat Tax requires 33% tax on all.
    3600B Budget and 12,000B Income.

    Sales tax is higher.

    We did not tax upper income is one big problem.
    Reagan gave 1% a 60% Income Tax Cut and borrowed 1700B
    Bush gave top 10% Big Tax cut and borrowed 6000B.
    Top Income 2009 of 4300B paid 17%.
    Exxon paid 10% of Total Income
    45B profit in 2010 watch what they pay.

    Corp now pay 5% of our Federal Budget as compared to 30% in past.

    Rich and Corp been gifted big time since 1980

    120,000,000 own 7% of Financial Wealth. Wall Street is dying to get that 7%.

    Only two ways out of Bush Disaster,
    Cut Defense–SS–Medicare–Medicaid Increase tax on rich and corp.
    CBO who fumbled the ball?
    Clinton left Bush Heaven On Earth
    Bush left Obama Hell on Earth

    Clinton left Bush an 1800B Budget
    Bush Left Obama a 3600 Budget

    Clinton left Bush a 250B Surplus
    Bush left Obama 1400B Deficit

    Clinton left Bush a 5700B of Debt
    Bush left Obama 11,800B of Debt

    Clinton left Bush a 237,000 net new jobs created per month
    Bush left Obama a 31,000 lowest since Hoover.

    Clinton left Bush Peace on Earth
    Bush left Obama Hell on Earth Two disastrous wars

    Clinton left Bush a President most highly rated of any peacetime President in Asia, Africa, Europe.
    Bush left Obama the most hated President in history
    Bush left Obama an Housing Tsunami and Financial Volcano
    Bush left Obama, in 2008, an 8500B Bail out commitment Yes! 8500 not just 700
    Bush left Obama his Takeover of Fannie/Freddie, AIG, and first bailout of Chrysler
     clarence swinney–political historian–lifeaholics of america burlington nc
    author-Lifeaholic–Life story of Workaholic failure to Lifeaholic success
    Best seller list at haw river gazette population 200
    comments welcome at cswinney2@triad.rr.com

  11. Michael Bindner  ::  11:05 pm on February 18th, 2011:

    Eliminating the tax cuts on the wealthy is not possible without eliminating all the temporary tax cuts. Indeed, with a Republican House, the only window for reform during Obama’s first term is the election of a Democratic House and seat pickups in the Senate, with action during a January lame duck session in 2013. Of course if Obama is reelected and these things occur, he can take his time.

    The more probably scenario is gridlock. In a strong economy, Obama wins – however in a middling economy gridlock results in letting the tax cuts for all die, while a poor economy means temporary tax cuts will stay with us – even though increasing taxes on the wealthy would actually have a STIMULATIVE effect by moving money from those who save it and fatten already fat corporate bank accounts to those who spend it – and afterall, consumption is the main component of economic growth.

    As to fiscal balance, the better answer is to not only reduce the deficit to interest costs (which negates the impact of the federal debt on the economy) but to begin paying off the debt – both as a percentage of GDP and in absolute terms.

    Doing that cannot be confined to the wealthy, nor should it be.

    I have laid out a scheme to do this, in my submission to the Fiscal Commission, which is posted on my web page from way back last summer (and was shared with TaxVox). Aside from miscellaneous excise taxes, there should be four major revenue streams, with each stream set to cover a separate set of expenditures.

    VAT should cover all domestic military and civil discretionary spending. To do that, the VAT would need to be on the order of 13.3%

    A separate Business Revenue Tax of 33.6% would include tax expenditures for families (a $500 per child per month refundable credit paid with wages) and the health care exclusion. Any other retained expenditures would necessitate a higher rate than 33.6%. This levy would fund entitlement and social spending (although this may be overstated, since it includes discretionary grant programs that may be better shifted to the VAT). It would not fund Old Age and Survivors Insurance (retired survivors over 60), but would replace payroll taxes on Disability Insurance, Hospital Insurance and Survivors under 60.

    A separate payroll tax would cover Old Age and old Survivors. This is mainly so it can be eventually diverted to personal accounts – else it might as well be part of the VAT so that it is funded by imports as well as wages.

    The final stream is a high income surtax (with distributions, but not assets, taxed as normal income). This would only apply to the higher 3, or possibly 2, brackets (depending upon the final BRT and VAT rates). It should fund overseas and sea military deployments (which would otherwise be paid with borrowed funds), net interest and debt retirment. Such a segregation turns the wealthy into both peaceniks and budget balancers, since they would be on the hook for future interest charges, not business taxpayers or their customers).

    What about cutting spending? These levies would incentivize it. VATs, which would be receipt visible, would lessen the demand for discretionary government, especially military waste (the bloated bureaucracy, with soldiers on briefing tours in the Pentagon participating in a Byzantine planning process known as PPBE) and pork barrell spending. Net interest would be reduced by the drive toward balance and repayment. Old Age Savings would not be reduced, but could be channelled from a governmental system to a personal account system where funds are invested in the employing firm rather than Wall Street, with a third held in an investment insurance fund, possibly maintained by the Fed). Entitlement spending could be shifted from the government to employer sponsored health, education, mental health care (in lieu of corrections) and anti-poverty programs at both the federal and state levels. This might make the spending much more effective, both in terms of programatic effectiveness and cost effectiveness – especially if third party providers like Catholic Charities, Lutheran Social Services, Catholic Health Care and the parochial school system expand their roles and are duplicated by other sects and faiths.

    If one does not wish to go so comprehensive, we could settle on letting the Bush cuts expire, cutting the Pentagon budget as suggested by the Fiscal Commission, introducing a smaller VAT or simply raising the Hospital Insurance payroll tax to fully fund the same share of Medicare costs that it did in prior years, plus a further increase to fund Medicare Part D (the base could also be broadened).

  12. Michael Bindner  ::  11:30 pm on February 18th, 2011:

    This all but gaurantees that Obama will let the entire package of tax cuts expire, even in a down economy. Indeed, if the economy stays down it is because he allowed to many rich and middle class people keep too much money in savings instead of letting taxes go up to put it in consumption.

    Conservatives are about to let the government be shut down. That and many of them are on the older side of the voting ledger. That gives them a temporary advantage and unless the latter half of the baby boom and Generation X become more conservative with age, the advantage will die with them – to put it very indelicately. Younger Latino voters will go Democrat – and they will increase in numbers – especially with ever increasing talk on repealing their birth right citizenship if their parents were undocumented.

    Under this demographic scenario, the fair response to your post is “What Republican Party?” They may soon become so small that they can join the Libertarians for a meeting in their phone booth.

  13. Michael Bindner  ::  11:33 pm on February 18th, 2011:

    It depends on how you define rich. In the Obama tax definition, it won’t work. However, if you use the highest quintile or even everyone over one standard deviation, it is quite doable, even if Obama won’t do it.

  14. Michael Bindner  ::  11:36 pm on February 18th, 2011:

    Cutting Medicare and Medicaid CAN’T happen, both because cuts to providers have providers opt out and beneficiaries go to the ER rather than to primary care physicians. The only realistic alternative is increased tax revenue from the Hospital Insurance tax – by both base broadening (everyone’s non-wage income or replacement with a VAT or Business Receipts Tax) and rate increases.

  15. SteveinCH  ::  11:56 am on February 19th, 2011:

    And the rationale for massively increasing the progressivity of the Federal tax code would be what, remembering that the Federal tax code has become more progressive since 1979 and since 2000?

  16. SteveinCH  ::  11:57 am on February 19th, 2011:

    Bull. You can easily cut Medicare expenses by means testing and it’s Medicare, rather than Medicaid, that is the real time bomb from a budgetary perspective.

  17. Secondary Sources: Deficit Reduction, Unemployment, Models and Risk | Photography Farm | Photography News, Galleries, Phorography Tips, TV Videos  ::  10:18 pm on February 19th, 2011:

    […] –Deficit Reduction: Howard Gleckman asks where a income will come from for necessity reduction. “If Washington is going to need new taxation revenues to move a necessity underneath control—which it fundamentally will– we increasingly consternation where a money is going to come from. If we listen to what……Read the Full Article at: http://blogs.wsj.com/economics/2011/02/18/secondary-sources-deficit-reduction-unemployment-models-and-risk/ […]

  18. John Thacker  ::  11:41 am on February 22nd, 2011:

    Really? Considering that this post detailed the tax rates necessary to get into balance with only one-third tax raises and two-thirds spending cuts, what would be the tax rates required for tax increases alone? Using the President Obama definition alone, it would seem to be over a 100% marginal rate (ignoring that certainly approaching that point the Laffer Curve would actually be relevant), but even using the highest quintile I don’t think it’s “quite doable.”

    If you’re saying that we can close the deficit by cutting spending and raising taxes, and restrict the tax raising portion to only the top quintile, that might be possible. But we can’t *just* tax the rich.

  19. Spiff  ::  11:14 am on February 24th, 2011:

    AND Bush had a DEMOCRAT Congress, and since only Congress, not the President, can pass laws and budgets, put the spotlight where it belongs – THE DEMOCRATS!
    Spiff

  20. Spiff  ::  11:21 am on February 24th, 2011:

    An overlooked fact is that the ultra rich, the Soros, Clintons, Kennedys, Kerrys, and many of the Obama administration, etc., don’t pay into the tax structure, they only take.
    Spiff

  21. torrent  ::  1:12 pm on March 7th, 2011:

    Let’s take a look at who is making the big money. Cap the NFL, NHL, NBA, PGA and others just for a few years, put it towards the deficit. They won’t starve like Middle America is going to.

  22. The Desperate Millionaire Surtax: An Idea for When You Lack Ideas « The Enterprise Blog  ::  2:14 pm on October 5th, 2011:

    […] gives the false impression that the way out of America’s debt trap is by taxing the rich. The Tax Policy Center ran a simulation where it tried to balance the budget by 2020 with two-thirds of deficit reduction […]

  23. The Desperate Millionaire Surtax: An Idea for When You Lack Ideas | Accounting News  ::  4:33 am on October 6th, 2011:

    […] gives the false impression that the way out of America’s debt trap is by taxing the rich. The Tax Policy Center ran a simulation where it tried to balance the budget by 2020 with two-thirds of deficit reduction […]