The Case for Higher Taxes
By UWE E. REINHARDT
Alan Greenspan, the former chairman of the Federal Reserve, opined on “Meet the Press” last month that to cope with the growing federal deficit the United States should go back to the federal income tax rates of the Clinton years. Such a step would raise tax rates for all American taxpayers.
I was reminded of that remark earlier this week at this year’s Princeton Conference on Health Policy, organized by the Council on Health Care Economics and Policy, housed at Brandeis University’s Heller School for Social Policy and Management.
In a session on “Future Health Care Spending: Political Preferences and Fiscal Realities,” Henry J. Aaron of the Brookings Institution presented this fascinating chart:
Center on Budget and Policy Priorities, based on estimates from Congressional Budget Office
Dr. Aaron was quick to add that he took the chart directly from an analysis by the Center on Budget and Policy Priorities. The chart illustrates how prominent a role the tax cuts of 2001 and 2003 have played in the buildup of deficits and public debt in the United States.
An additional factor, of course, has been the economic downturn (dark blue), along with two wars. Evidently, the stimulus package (the bulk of the “recovery measures”) played a role as well, although probably not nearly as prominent a role as seems to have been widely assumed.
This next chart, taken from a report by the Congressional Budget Office, illustrates more clearly the shock that the deep recession brought on by the financial crisis dealt to American fiscal policy, on top of dubious decisions in those policies.
Congressional Budget Office, Feb. 15, 2011
It can be seen that the “politics of joy” – granting tax cuts without commensurate cuts in government spending – began in earnest in the 1980s. That strategy was briefly interrupted by President Clinton who, as legend has it, was converted by his Treasury secretary, Robert Rubin, to worship the bond market and therefore sought to keep interest rates low by sharply lowering the federal deficit.
In that lapse into fiscal responsibility the Clinton-Rubin duo found support, after 1994, with a Republican Congress and a House of Representatives firmly led by Newt Gingrich.
Sadly for fiscal policy, the politics of joy was revived with the tax cuts of 2001 and 2003. To my mind, the pièce de résistance of that era was the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which bestowed on the nation’s elderly, known to be active voters, a large and generous entitlement that was entirely financed by the deficit. It is projected to add close to $1 trillion to the federal deficit during the current decade alone, and much more in decades beyond.
Starting in 2008, the deep recession saw federal tax revenues plummet as federal outlays soared, driven in part by economic stabilizers like unemployment insurance. Large deficits are a natural byproduct of deep recessions.
As early as January 2009, two weeks before President Obama took office, the Congressional Budget Office projected in its “Budget and Economic Outlook” a federal deficit of close to $1.2 trillion. As the chart above shows, the federal government now budgets with red ink as far as the eye can see.
The chart demonstrates a chronic affliction of American politics aptly diagnosed by Douglas W. Elmendorf, director of the Congressional Budget Office:
The United States faces a fundamental disconnect between the services that people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services.
Note that Mr. Elmendorf does not accept the usual folklore — that Americans are inherently mature and fiscally responsible and are victimized by a sinister, alien force called government. Rather, he asserts that we, the people, have time and time again favored at the ballot box politicians who promise tax cuts, even though a mature people would have noticed long ago that government spending will never be cut commensurately – mainly because, as voters, we do not countenance major spending cuts, either.
We are now seeing this adolescent posture on fiscal policy playing out once again, as voters angrily react to the recently passed House of Representatives budget plan. And it explains why my friend and fellow economist Eugene Steuerle of the Urban Institute, who served at the Treasury under President Reagan, has aptly and with exasperation named his periodic column on United States fiscal policy: The Government We Deserve.”
Looking at the Congressional Budget Office’s chart, I came away convinced that Mr. Greenspan had it right: given what we, the people, expect the federal government to deliver – including, once again these days, a social insurance program called “federal disaster relief” — the only way to avoid a looming fiscal disaster would be to return to the higher taxes across the board that prevailed during the Clinton administration. (An alternative would be to bite the bullet and adopt a value-added tax, as other nations have done.)
Would this make America a relatively overtaxed nation? Not by international standards, as can be inferred from data regularly published by the Organization for Economic Cooperation and Development.
Organization for Economic Cooperation and Development tax database
There is little evidence of a strong, negative correlation between total taxes as a percentage of G.D.P. and economic growth, as is suggested by the chart below (for a similar perspective, see this).
Organization for Economic Cooperation and Development
This is not to say, of course, that a nation’s rate of economic growth is impervious to the composition of its total tax burden – what fraction of taxation comes from levies on business income compared with that on individual incomes, the level of marginal income-tax rates and so on.
One should think, for example, that judiciously targeted investment tax credits would encourage economic growth, or tax preferences for start-ups.
On the other hand, it has never been clear to me in what way granting tax preferences to gains from trades in already existing assets — like those on long-term gains on already issued stock certificates or gains on speculating on the value of already built real estate — feeds economic growth.
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