In the presidential debate Tuesday night, the two candidates vied for
who could cut the most taxes. “Let’s not raise anybody’s taxes,”
proclaimed McCain, while Obama promised a tax cut for 95% of Americans.
These pledges may be music to the ears of American taxpayers, but they
make no sense in a time of soaring budget deficits and huge new
government expenditures, including probably a trillion dollars for the
financial bailout. When the federal budget is so out of whack, as The New York Times'
David Leonhardt points out, “taxes will have to rise or government
spending will have to fall, if not both.” Leonhardt's sobering but
sensible column is aptly titled "Ignoring Reality Has a Price."

Even
before the bailout, the Bush administration was handing over to its
successor a $550 billion budget deficit. With the costs of the
financial bailout, Leonhardt estimates, that is more likely to be $750
billion. This is the largest ever annual deficit in absolute terms and
the largest as a percent of GDP—5%--since 1983. The federal debt has
now topped ten trillion dollars, and last week Congress raised the debt “ceiling” to $11.3 trillion.

In
the face of these huge deficits and new obligations—not to mention the
looming problems of funding Social Security and Medicare—the only
solution is to increase federal revenue. The only real source for that
is personal and corporate taxes. Taxes will have to be raised, and
probably for almost everyone. This need was true even before the
current crisis. In 2004, the International Monetary Fund, normally
concerned with debts and insolvency in poor countries, raised the alarm
about U.S. fiscal deficits and the “significant risk” these posed for
the rest of the world. The IMF estimated then that to close the
long-term structural deficit in the U.S. would require “an immediate
and permanent 60 percent hike in the federal income tax yield, or a 50
percent cut in Social Security and Medicare benefits.”

The
Bush administration has compounded these long term problems by
combining record spending with cuts in taxes—causing these
unprecedented deficits and debts. It is difficult to see how we can
avoid increases in federal
spending (in the short run, at least) to stop the bleeding of the
current financial mess. So tax cuts, by reducing federal revenue, will
simply compound the long term problems.

Some politicians and
economists (especially “supply-siders”) argue that tax cuts can be made
up for by increased consumer spending and economic growth, which will
in turn generate more tax revenue. But there is virtually no historical
or economic analysis that supports this assumption. Even Fed Chairman
Ben Bernanke admits that tax cuts “usually do not pay for themselves.” (New York Times, 11/9/07). And former Secretary of Commerce Paul Peterson observed in his book Running on Empty
that the tax cuts of the Bush administration were “an obligation driven
by faith, not a policy guided by evidence.” The same is true now, even
more.

The problem is that Americans are thoroughly accustomed to
not paying for the benefits we enjoy. Compared to other wealthy
countries, the U.S. has among the lowest rate of both individual and
corporate income taxes. Total tax revenues in the U.S. (as a percent of
GDP) are substantially lower than all of the affluent democracies that
are members of the OECD.
The only OECD countries that have lower taxes on this scale are Mexico
and Korea—the two least developed countries among the thirty.
Furthermore, in the U.S. federal tax revenues as a percent of GDP have
actually declined since the year 2000.

In the presidential
debate last Tuesday, there was some recognition, by Senator Obama at
least, that the current crisis was going to require belt-tightening by
American citizens. “All of us are going to make sacrifices,” Obama
said. This is not an easy message for a politician to convey, and even
more difficult to carry out. It will require wise leadership to do so.