Tax Cuts Will Make Things Worse
October 21 2008 / by DSMason
Category: Economics Year: 2008 Rating: 11 Hot
Cross-posted from The End of the American Century
Both Obama and McCain have promised to cut taxes, but in the face of record deficits and debt, huge bailouts, and pressing social needs, taxes have to go up, not down.
In the presidential debates the two candidates have bickered over who would cut the most taxes. “Let’s not raise anybody’s taxes,” says McCain, while Obama promises 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, and with so many pressing needs, taxes have to go up, not down.
Even before the bailout, the Bush administration was handing over to its successor a $550 billion budget deficit for the 2009 fiscal year. With the costs of the financial bailout, that is more likely to grow to $750 billion. This would be 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, would 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 admitted late last year that tax cuts “usually do not pay for themselves.” And former Secretary of Commerce Pete Peterson—a Republican—has observed 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 in 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.
Comment Thread (6 Responses)
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I agree that it’s unwise to lower taxes at this stage, especially for larger companies (across a variety of sectors) that may need to fail to make room for the leaner, more innovative businesses. We should gradually push them up and resist the urge to slice at politically opportune moments.
But I do see one additional method of generating revenue: government driven innovation. A serious push to produce new efficient energy, comm, info and medical technologies could net the U.S. some nice patents / manufacturing processes that could then be licensed, sold or traded to other countries.
While this cross-over into private industry may seem unlikely, I do think that a more serious downturn could make such a strategy very plausible – a high-tech, in-the-end-profitable, New New Deal, or such.
Certainly we’re not going to solve this mess with higher taxes, unless accelerating change transforms the economy unexpectedly quickly, which I am absolutely not counting on.
Posted by: Alvis Brigis October 21, 2008
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Everyone wants roads and highways and benefits, but no one wants to pay for them. I’d be willing to pay 50% taxes myself if it meant better public transportation, schools and healthcare.
Posted by: John Heylin October 21, 2008
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I agree with Heylin. But I am not schooled enough in economics to know if that would actually help. I guess what I would like to know are there taxes that we know hurt the economy so much that the government would actually get less revenue or would raise the unemployment rate and are there taxes that are relatively no brainers but aren’t implemented for political reasons?
Posted by: Mielle Sullivan October 21, 2008
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Raising taxes is noble IF the money goes where its supposed to and that is rarely the case. Infrastructure needs to be improved but most of the time the extra money in the government’s coffers goes to fighting wars, which we’re going to be fighting for a long time to come in the Middle East.. I do not want to give the government 50% of my income anytime soon.
Posted by: Covus October 21, 2008
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Mr. Mason presents a compelling – if incomplete – case for half the circumstance at issue.
First, the incomplete. US history contains several examples of tax increases proving beneficial to the country. Mostly in relation somehow to periods of war, as Covus observes. There are also at least as many examples from the country’s history of the country benefiting financially from tax reductions. These have taken the form of reductions in the rate of collection or outright abolishment of a tax liability entire. I should point out that “benefit to the country” means that government collections increased as a result of the tax change and there was little to no apparent negative impact on the national economy as a result either. For this last example, look to the early years of the JFK, Reagan and GW Bush presidencies for examples of beneficial cuts in rate and the Hoover administration for tax abolishment examples from only the 20th – often called “the American” – century.
Whether or not this particular point in US history falls into one of these general conditions or the other (or some other still) is an open – and for this discussion irrelavent – question.
Second, the other half. I make that claim because Mr. Mason’s presentation fails to correct for the actual cause of the present financial deficit – government spending. In particular, government spending beyond the level of previous revenue collections. I submit that it is this addressed-but-undealt-with aspect of government fiscal irresponsibility that most directly accounts for the present state of US national financial insecurity.
Without achieving – and enforcing – some mechanism to halt government (read: Congressional*) deficit spending, any attempt to restore fiscal stability to the national economy is doomed to be an exercise in frustration. At best. And so far we seem depressingly far from achieving even that degree of “success”.
Just for the record, I would argue that the record of increased tax collections resulting from tax rate cuts outweighs the war-time considerations at this point in the current martial proceedings. However, without a broad and deep reduction in the level and scope of federal spending, any effort to improve the financial prospects for the government and the country as a whole is doomed to ultimate failure. I should also point out that, as someone who is just entering the AARP primary demographic target zone, I am well aware of the likely implications resulting from my prescription. The medicine doesn’t have to taste good to be effective or necessary.
All that being said, I fully expect that we as a nation will continue our climb out onto the lip of the skillet, all the while shoveling fuel to the fire.
I also have to say that attempting to foist a campaign issue from the 1964 election cycle onto the present Bush administration strikes me as profoundly ignorant. Particularly since both Goldwater and Johnson agreed at the time that the social security system was insolvent – the disagreement being over whether this was a bug or a feature. GWB has provided a sufficiency of insufficiency all on his own, sad to say, there’s just no need to go making stuff up folks.
- I will stipulate that every president bears a full share of the fiscal responsibility too, if only through having signed the deficit budget into law. As ever, the devil is in the details.
Posted by: Will October 22, 2008
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All these comments make good sense. I would respond to Will’s thoughtful remarks in two ways:
1) The argument in my original post was that tax cuts do not pay for themselves in terms of increased government revenue. I think most economists agree with that point. And if you look at the last two major tax cuts, those of Reagan and Bush II, both of them led to HUGE increases in government deficits.
This is not to say that tax cuts can not serve some other purpose, which they often do. But they do not usually increase government revenue, as the supply-siders used to argue.
2) I agree that government overspending is a problem; the government should be spending (roughly) only as much as it brings in. But unless we want major cuts in government programs (including health care, education, social security, etc.) taxes will have to be raised to close that gap.
Posted by: DSMason October 31, 2008
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