Can the Income Tax Fund the Government We Want?

By :: February 5th, 2013

Can the income tax fund the government we seem to want? Probably not.

Will lawmakers create a revenue system that will? Not anytime soon.

That was the consensus of four tax policy experts at an Urban Institute panel I moderated this afternoon. The panelists--historian Joe Thorndike, Urban Institute economist and tax reform veteran Gene Steuerle, Tax Policy Center co-director Eric Toder, and IRS taxpayer advocate Nina Olson-- agreed that the current Swiss cheese of a revenue code is not up to the task, at least not in the long-term.  

And they agreed that someday, the federal government will turn to some form of a consumption tax to help make up the difference. It may be a broad-based levy such as a Value-Added Tax or an energy tax. It might replace the current income tax, or might be added on to the existing system. But given political gridlock, any form of major reform is years away.    

As they were speaking, the Congressional Budget Office released its own fiscal update for the next decade. And, by CBO’s estimates, the panelists are self-evidently correct. While a growing economy will bring the annual deficit down to about 2.4 percent of Gross Domestic Product by 2015 (assuming, among other things, that discretionary spending remains capped in the way Congress and President Obama have agreed), the red ink will begin flowing faster again. By 2023, the deficit will be back to 3.8 percent of GDP and rising.

If, as is more likely, those spending caps erode and a raft of temporary tax cuts don’t expire as scheduled, the deficit will be closer to 5 percent of GDP in a decade. And, as 77 million aging Baby Boomers require more health and long-term care, deficits will head upwards in the decades after that.

There seems to be little political will, at the moment, to make major changes in Medicare or Social  Security. At the same time, the income tax remains riddled with preferences and other subsidies.

As a matter of math (as everyone used to say in the recent campaign), Congress could balance the budget in 2014 by eliminating about half the value of those tax expenditures. But since these are subsidies for such All-American activities as taking out home mortgages, getting employer-sponsored health insurance, paying state and local taxes, and making charitable contributions, Congress is unlikely to cut them in half anytime soon.

As long as these subsidies remain on the books, the income tax’s ever-narrowing base simply cannot support the nation’s spending demands. With the top tax rate now over 40 percent (including the phase-outs of the personal exemption and itemized deductions), Congress may be reaching the limit of its ability to continue to raise rates without facing the law of diminishing returns.

That leaves a consumption tax of some kind. But in the absence of a fiscal crisis (such as rapidly rising interest rates) lawmakers are not likely to travel that road any time soon, the panelists figured. So we will continue to muddle along, with an income tax that is ever-more complicated, harder to administer, and increasingly inefficient.

This afternoon’s panel celebrated (if that is the word) the 100th anniversary of the ratification of the 16th Amendment, which created the modern income tax. The levy has been remarkably resilient over the past century, but without a huge change in the public’s appetite for federal spending (especially for health care) it is hard to see how the income tax as we know it can last another 100 years.        






  1. Apollo at  ::  10:57 pm on February 5th, 2013:

    I’m personally curious to see how the spending side of the equation changes in the next decade. Several economists (most notably Krugman) have suggested that much of the present deficit is attributable to a subpar economy than an overwhelming and permanent cash flow imbalance. Social security actuaries have noted that a modest change in the SS tax can significantly lengthen the solvency period for the program. And, with Obamacare becoming active in 2014 and the wars abroad drawing down, defense and health care costs stand a better chance of shrinking (or, at least, growing more slowly) than they have in ages. While no ones loves the income tax, these trends may have the strength to fend off a consumption tax for a few more years to come.

  2. AMTbuff  ::  11:13 pm on February 5th, 2013:

    “without a huge change in the public’s appetite for federal spending…”

    Why does the public prefer large government? Because we’re not paying for it!! The cost is being pushed into the future, Ponzi-style. Ponzi schemes are VERY popular while they work, and very unpopular after they fail.

    The “huge change in the public’s appetite for federal spending” will come when the Ponzi scheme fails. And it will fail, sooner, faster, and more completely than any pundits currently predict. We are too large to limp toward complete bankruptcy like Argentina. We can only crash.

  3. Tax Roundup, 2/6/2013: 4.5% Iowa tax? Flat chance. And hidden dangers of an IRS exam. « Roth & Company, P.C  ::  9:54 am on February 6th, 2013:

    […] Gleckman, Can the Income Tax Fund the Government We Want?  (TaxVox).  I can’t speak for “we,” but it could easily cover all of the […]

  4. SteveinCH  ::  11:46 am on February 6th, 2013:

    Do you mind if I say, “Not so much.”

    The CBO is forecasting that if the budget caps in the BCA hold for a decade, the SGR changes happen, inflation stays modest, and there are no major downturns in the economy for a decade, spending will still rise at a rate of 5.3% per annum from 2023 to 2033.

    Perhaps that’s somebody’s definition of slower spending growth but not mine.

  5. Michael Bindner  ::  8:47 pm on February 6th, 2013:

    I wish you had given me a seat on the panel. I would have pointed out that a consumption tax of some kind may come in sooner than we think. As I have been pointing out, if subsidies for health insurance under the Affordable Care Act are inadequate to get the uninsured to enroll before getting sick, the value of health insurance stocks will tank long before the first policy is even sold, leading to either a collapse of the private insurance system and its replacement with single-payer (financed by a consumption tax or payroll tax) or a public option for those who can’t get insurance, subsidized, again, with some form of payroll tax or consumption tax. Either change will be large enough to absorb any minor long range budgetary problems in current programs. Of course, the real answer is to increase the child tax credit so we have more kids (including anchor babies), so that the number of workers and consumers can support the retiring boomers.

  6. Apollo at  ::  10:59 pm on February 6th, 2013:

    I don’t mind. What’s the saying? “Prediction is very difficult – especially about the future.”

    I would appreciate a reference, though. The latest I found after a quick search was this one: I couldn’t find the 5.3% you mention.

    Spending is going to grow – demographics force our hand on that one. The question is, “Are we going to pay taxes to keep up with it, or debt finance it?” If we debt finance, the service on the debt will eat our lunch in the long run. If taxes at least keep up with it (debt stable or shrinking) due to changing tax rates or, preferably, economic growth, we have a shot at a decent long term solution.

    Of course, we all know what happens in the long run.

  7. SteveinCH  ::  9:26 am on February 7th, 2013:

    Sure. The latest CBO forecast…

    …has spending at $3.553 trillion for FY2013 and $5.939 trillion for 2023. That’s a 5.3% CAGR over the period. In real, per capita terms, based on the inflation forecasts in the CBO document and the population forecasts from the Census, it’s about 2.5% real growth on a compounded basis.

    Sure spending is going to grow but demographics don’t cause it to grow by 5.3% per year. Demographics and inflation yield spending growth between 3 and 4 percent per year. The rest is just government doing what it does. If you take the growth rate of spending down to 3% per year, tax receipts quickly catch up because they tend to grow faster than nominal GDP growth.

    So, in other words, it’s back to whether we are willing to put government on a COLA. If we tell government…hey, you can only increase spending as fast as the growth of population and inflation and we stick with that, we fix the deficit. I don’t expect that outcome as we’ve never seen it before (well actually, we did see it in the 90s but we couldn’t sustain it).

  8. Still No Straight Talk On Taxes | The Penn Ave Post  ::  6:30 pm on February 8th, 2013:

    […] by Andrew Sullivan After moderating a tax policy discussion between four experts, Howard Gleckman delivers their less-than-optimistic conclusions: Can the income tax fund the government we seem to want? […]

  9. ThomasH  ::  12:47 pm on February 9th, 2013:

    I question the starting assumption that the personal income tax cannot raise enough revenue to balance the budget in the long run if the current trajectory of expenditres is desirable. I agree, however, that a progressive consumption tax would be better.

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