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With President Obama’s fiscal commission getting under way, we pose a question based on preliminary talks: Why in the world is the discussion centering on adding still more taxes– specifically, a Value-Added Tax, or VAT – to a horrendous economic picture that threatens to saddle Americans with onerous tax burdens never before seen in the US?
The answer is very simple: the straight-forward story of fiscal challenges we face is still not being discussed. Until it is, we won’t begin a serious discussion of solutions.
Part of the confusion arises from artful – if disingenuous – political positioning by advocates of higher taxes and spending. One of their pitches is particularly irresistible to many in the press: everyone just needs to compromise – and specifically that Republicans need to be willing to talk tax increases if Democrats agree to discuss cutting spending. After all, fair is fair.
One reporter has even established “Club Wagner,” dedicated to the principle that taxes must rise because Americans demand a bigger government. The club is named for Adolf Wagner, who opined that governments of wealthier civilizations should rightly impose steadily escalating tax burdens on their citizenry.
We suggest that the devotees of Wagner more closely scrutinize the damage his philosophy has inflicted upon Europe’s long-term economic and demographic outlook. It is also highly debatable how much Americans are truly clamoring for the ongoing expansion of federal spending.
Within the echo chamber of the American left, it is assumed that federal health and retirement obligations must naturally swell and that this swelling is a good thing. But contrary to the idea that American are clamoring for higher spending, Congress and the Administration recently defied broader public opinion in enacting a massive expansion of federal health care spending. Raising taxes to fuel the entitlement spending binge may not actually finance what is desired by the general public so much as it funds policy initiatives foisted by the governing class upon a skeptical population.
But all of that is a subject for another day. Here, let’s simply discuss the ostensibly equitable posture that tax increases and spending restraint should occupy similar places on the negotiating table. At first glance, this would seem to establish a reasonable symmetry between negotiating positions.
But that picture would be very wrong. The merest glance at the numbers reveals a very different reality. First, let’s look at the long-term budget picture under current law as seen by the Congressional Budget Office (CBO).
A quick glance at this graph reveals that the long-term problem is not one of inadequate revenues. If we don’t change the law so as to reduce tax growth, Americans will be taxed as they have never been taxed before. As CBO explains:
“The extended-baseline scenario assumes that current law remains in place. . . After 2019, revenues would rise relative to GDP. Over the 2009–2035 period, they would rise from almost 16 percent of GDP in 2009 to almost 22 percent in 2035, an increase of roughly 6 percentage points (see Figure 5-1). Over the long term, the cumulative effects of inflation and real (inflation-adjusted) growth in income interact with the tax system . . . The result is higher average tax rates – that is, taxes as a share of income – and a significant change in the distribution of taxes. Under the extended-baseline scenario, the cumulative effects of inflation would cause nearly half of all households to be subject to the AMT by 2035 and almost three- quarters of all households by 2080; at that point, revenues would reach 26 percent of GDP.”
Thus, revenues are projected to rise for several reasons: because an unrepaired AMT will capture more and more Americans over time; because the 2001 and 2003 tax rates are assumed to expire; and because bracket creep will relentlessly push more Americans into higher marginal tax rates. (Income tax brackets are indexed only to price inflation, so as real income steadily rises faster than inflation, more Americans drift into higher brackets where the government takes a larger bite.)
What are we to make of this daunting picture? Well, for starters, it’s hard to believe the dramatic effects will really occur based on past actions by Congress. Both parties cooperate sporadically to hold back the increasing grasp of the AMT, and neither party wants to see the 2001 and 2003 tax rates repealed in full. At some level, there is bipartisan recognition that permanently imposing such rising tax burdens would result in an enfeebled American economy, European-style stagnation, and lower after-tax standards of living for our children. Members know that Americans rightly expect their political servants to deliver them from this unpleasant scenario.
This also means that our deficit problem is much worse than it first appears. Our long-term fiscal problem isn’t merely the gap between the blue and green lines in the previous chart. Both parties agree that the green line actually needs to come down. Once we admit that, it’s easy to see that we have even more work to do to contain the growth of spending.
This is one reason why the CBO publishes an “alternative fiscal baseline”, which assumes the more plausible scenario that the 2001/03 tax cuts remain in place and that the AMT is permanently indexed for inflation. The Administration’s OMB publishes a similar “current policy” baseline which, as we have seen, has enabled it to engage in various double-counting gimmicks: simultaneously claiming that they are providing tax relief while still applying more than $1.7 additional tax revenues to deficit reduction over the next ten years.
But even under CBO’s “alternative” (more realistic) baseline, taxes over the long term would still climb well above historic norms. Despite this, deficits and interest spending would soar to stratospheric levels – a picture obscured by the Administration’s emphasis on “non-interest” spending alone – as seen below.
Yet even this “alternative fiscal baseline” may not be fully reflective of political reality. The Center on Budget and Policy Priorities publishes yet another revenue baseline that assumes the same changes as in CBO’s baseline, plus additional extensions of “certain other temporary tax provisions.” Under the CBPP baseline, long-term tax burdens would remain close to historic norms (18.2% of GDP in 2050). Like other tax hike advocates, CBPP bases its argument in part on the fact that expected changes in tax law will reduce revenue growth significantly relative to the “current-law” baseline.
The various arguments for higher taxes are thus largely rooted in a world-view in which the “current-law” tax baseline never comes to pass. But regardless of what anyone thinks might happen with future tax policy, the stubborn fact remains that taxes will rise dramatically in upcoming decades under current law if the 2001 and 2003 tax cuts do indeed expire. Clearly, as long as current-law tax policy actually comes to pass, enacting still further tax increases on top of the ones already scheduled to occur makes little policy sense. Unless and until the current-law revenue curve is bent downward, the problem is clearly one of spending, and further tax increases should be off the table.
We wouldn’t necessarily favor raising taxes even under CBO’s “alternative baseline” or under the CBPP baseline scenario. Nevertheless, it is reasonable to discuss the full variety of means to bridge a gap between having a spending total that’s roughly 40% of GDP with taxes totaling roughly 18% of GDP in 2050 (as foreseen by CBPP). And this brings us to one potential resolution of the negotiating impasse.
The obvious way to square this circle is to make the current-law and the current-policy baselines the same by enacting the tax law changes that some merely wish to “assume” – specifically, the permanent extension of the 2001 and 2003 tax cuts, permanent inflation indexation of the AMT and perhaps (pursuant to the CBPP concept) other temporary tax provisions that have bipartisan support. If there is agreement on that, then the discussion about raising taxes can fairly take place. The advantages of this course would be several.
First, it would be good policy. It would spare our children and grandchildren from skyrocketing tax burdens waiting under current law.
Second, it would more honestly lay bare the true size of our fiscal predicament. It is dishonest to pretend that our fiscal problem is smaller than it is by assuming the increase of future revenues, when we all know that at the very least Congress will continue to “patch” the AMT and that most of the 2001/03 tax cuts will be extended.
Third, it would eliminate a major source of hypocrisy in our budget debate. For too long, politicians have railed against the 2001 and 2003 tax cuts while secretly favoring them and betting on their extension. If Congress doesn’t want to continue the 2001 and 2003 tax policies, it should forthrightly inform Americans as to whose taxes are going up. If instead Congress plans to extend them, and the AMT patches as well, it should do that once and for all – rather than paper over our deficit with estimates of projected tax revenues Congress never plans to collect.
Fourth, this move would eliminate the current confusing multiple-baseline budget presentations as well as misleading rhetorical gimmicks. CBO would no longer need to publish two alternative baselines and OMB would no longer have reason to generate its own separate “current policy” baseline. CBO and OMB would each define the effects of the President’s policies the same way as one another, and confine their arguments to the technical projections. And, OMB would stop the rhetorical games in which they claim to be cutting taxes but increasing federal revenues at the same time.
Finally, our assumptions would at last match reality. Is the reason some think we need a VAT because they assume that revenues will decrease when the 2001/03 tax policies will be extended, and the AMT perpetually “patched?” There’s an easy solution to that, then: align the law with those assumptions, and then talk about raising taxes.
The worst of all policy worlds would be to leave on the books a set of unrealistic, undesirable tax policies driving revenue collections to crushing levels, while enacting yet another large tax – VAT or otherwise – to compound the damage.
Should Republicans on the commission be willing to talk about tax increases? Absolutely – but not in the context of the current-law tax baseline. If they can first secure a permanent extension of the 2001/03 tax cuts, and a permanently indexed patch for the AMT, then tax increases can be discussed in an environment that is equally fair to both parties, mindful of reality, and tending towards good policy.
