Why Higher Taxes Will Have to be Part of the Medium- and Long-Term Fiscal Solution

By :: January 23rd, 2012

If we are going to reduce the medium- and long-deficit, new tax revenues must be part of the solution. And those taxes must be progressive and as conducive to economic growth as possible.

Historical revenue levels will not be sufficient to fund the federal government in the future. We will need to control the ballooning costs of Medicare, Medicaid, and Social Security. However, because their enrollment will be growing with the aging population, additional revenue still will be needed.

Past major budget agreements included both revenue increases and spending cuts because using both sides of the budget provides a sense of fairness and shared sacrifice. Americans prefer a balanced approach to spending cuts alone

Interestingly, raising taxes has proved more effective at restraining spending than allowing the government to finance its outlays with deficits. Under presidents Reagan and George W. Bush, taxes fell but spending rose. Spending fell only in the 1990s, when President Clinton and Congress raised taxes. This makes sense, since raising taxes to pay for current spending makes it clear to taxpayers that there is a cost to current spending, whereas the cost of deficit financing, while real enough, are obscured by the fact that it is does not create current tax liabilities.

Done right, higher taxes will not destroy the economy. In 1993, top income tax rates rose to 39.6 percent, and the economy flourished for the rest of the decade. Even the massive tax increases during and after World War II-amounting to a permanent rise of ten to fifteen  percent of GDP-did not hamper U.S. economic growth. 

The best way to raises taxes is to broaden the tax base by reducing the number of specialized credits, deductions, and loopholes. For example, limiting the tax benefit of itemized deductions to 15 percent would affect mostly high-income households and raise more than $1 trillion over the next decade without raising marginal tax rates.  

New revenues should come from a progressive tax, which means the tax burden on high-income, high-wealth households needs to rise. Last year's debt deal contained only spending cuts that place almost the entire burden of closing the fiscal gap on low- and middle-income households but have little or no impact on high-income households.

Over the past 30 years, the share of total household income for the top one percent of the income distribution more than doubled. Yet, those high-income households have seen their average tax burden fall, not rise, during that period. 

The claim that these tax  increases will harm small business is often overstated. Most income for high-income households is not business income. Yet, a recent Treasury report shows that just 1 percent of small business owners would be affected by a "millionaire's surtax." And even those firms face effective tax rates likely to be zero or negative since they can immediately and fully deduct the cost of new investment, even as they finance it WITH tax-deductible debt.  

In addition to income tax reform, our leaders should move the United States toward a system that taxes consumption (using a value-added tax for example) and nonrenewable and polluting energy use (by increasing gasoline taxes or implementing a carbon tax).

The VAT exists in about 150 countries worldwide. It can raise substantial revenue, is easily administrable, and is minimally harmful to economic growth. In addition, a pre-announced, phased-in VAT could accelerate economic recovery. Concerns about regressivity and transparency can be addressed, and concerns that it would fuel an increase in government spending are overstated. 

Long-term challenges related to energy production and consumption and long-term fiscal challenges can be addressed together. A far-reaching, upstream carbon tax can reduce the deficit and our dependence on foreign oil, protect the environment, lower the costs of healthcare, and encourage the development of clean, sustainable energy sources without the need for costly, inefficient energy subsidies. In the absence of a full-blown carbon tax, raising the gas tax offers many of the same advantages.

None of this means the United States needs to move to European levels of taxation. But between the very low tax revenues we raise now-the lowest share of the economy in six decades-and the high levels of taxation in other developed countries, there is room to raise revenue in a way that achieves serious medium- and long-term deficit reduction and supports a reasonable level of government.

 

12Comments

  1. Toby  ::  3:12 pm on January 23rd, 2012:

    This communistic wet dream sounds like something emanating from leftist loonies like the Urban League and the Brookings Institution; perhaps a bit too centrist for a real bunch of anarchists like the Center on Budget and Policy Priorities.

  2. Michael Bindner  ::  4:21 pm on January 23rd, 2012:

    If you count tax subsidized private health insurance as public spending, we are already at European levels, as Bruce Bartlett showed in his Economix piece on the subject last year (it is also in his forthcoming book, the Benefit and the Burden). The challenge for tax reform is to use it to increase tax benefits for lower wage families, which can be done through a VAT-like Net Business Receipts Tax so that most families no longer have to file. Tax benefits for health care for workers and seniors can continue to come out of that tax, which will replace the corporate profits tax, as well as any other tax benefit used to transfer performance of government services from government agencies to employers or charitable contributions funded through employers. For example, welfare could be shifted to an adult education program run by the faith community – Catholic remedial school – with the school doing all the supportive services as well (health care, family dormitory housing, food service).

  3. Tuesday Tidbits | Dirigo Blue | Maine's Source for Progressive Political News  ::  7:23 am on January 24th, 2012:

    […] released returns show that Romney paid $3M in income tax in 2010. The Tax Policy Center explains why higher taxes will have to be part of the medium- and long-term fiscal solution.From Forbes: if you thought SOPA was bad, just wait until you meet ACTA.Republican Rep. Ron Paul of […]

  4. AMTbuff  ::  1:08 pm on January 24th, 2012:

    Higher taxes absolutely will be part of a long-term fiscal solution. They are unlikely to be part of a non-solution. Until benefit programs are reformed in a way that credibly caps their cost (as a percentage of GDP), voters will not support throwing good money after bad.

    Governor Brown will demonstrate this in California soon. In November 2012, California voters will approve or deny a state income tax increase on the rich. I believe that the voters will refuse unless public pension liabilities are adequately reduced. Brown has shown no intention to fight the public sector unions this year, or any other year. In November California voters will be asked to throw good money after bad. I predict they will say “No”.

    This is a wasted opportunity, since a “Yes” was achievable had the tax increase been paired with the necessary reductions in promised benefits. As a Democrat, Governor Brown was in the perfect position to put an actual solution in front of the voters. Like his predecessor, he preferred to save his own job rather than save the state.

  5. Peter  ::  3:31 pm on January 24th, 2012:

    When they raise the 1%ers tax rate to be the same as mine and make sure they pay by strict audits, then I’m all in favor of the scheme. However since my taxes get sucked out at source and I can’t hide my money, then why should I pay more that Warren Buffet or any of the others at the top of the food chain?

  6. Steve Hornig  ::  9:11 am on January 25th, 2012:

    I get incredibly frustrated by people who say one group needs to pay “more” relative to others in order to achieve “fairness”. My frustration comes from the fact that these words are very imprecise. I also get frustrated when authors don’t look at historical averages to gage whether and how much taxes need to be raised versus reductions in spending – in order to return to historical averages.

    Give my frustration, I ask: How much more tax should a rich man pay than a poor man on each dollar earned? Five times? Ten times? Twenty times? Secondly, in order to get us back to 50 year historical averages, most of the problem is on the spending side. If for some reason an eventual return to the average doesn’t work for an author, I ask them to please explain why they believe a paradigm shift has occurred.

    I have devised a twelve point tax plan called the Nickel, Dime, Quarter Tax which requires a rich man to pay five times more than a poor man and vastly simplifies our Internal Revenue Code. I commend it to your reading at http://www.nickeldimequartertax.com.

  7. Adam Boatsman  ::  3:03 pm on January 27th, 2012:

    We already have explicit taxes (income, ad valorem, excise, sales) and implicit taxes (increased health care costs, lower entitlements).

    Although perhaps an impossible solution it would seem to make sense to look at the total picture for the citizen, both implicit, and explicit, across all jurisdictions to define a truly fair policy – as a change in one jurisdiction will no doubt trigger a corresponding, and often punitive, change somewhere else.

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