Tax Cuts Will Make Things Worse
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.
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.
