Monday, July 4, 2011

Debt and Taxes

I keep thinking I should say (write) something about the whole debt ceiling business.  I've got a few semi-connected thoughts on the topic, most of them more about the process than the philosophical side.  First of all, I think that the political gamesmanship just stinks.  Even if we were to hit the ceiling, the secretary of the treasury can prioritize payments so that the most important stuff gets done first.  All of the scare tactics about a national default are just that.  However, the political calculus is that if it comes to that, Tim Geithner would be politically smarter to hold up soldiers' pay or social security checks rather than cutting a penny of mohair subsidies, corporate welfare, or any other non-essential services.  I understand how it works, but it's a great deal like a hostage situation.

Secondly, the whole notion that we can't make any spending cuts without tax increases irks me, as well.  I seem to recall very recently we had a chance to revert back to the Clinton-era tax rates.  Indeed, doing nothing would have caused that to automatically happen.  But congress passed, and the president signed, an extension of the Bush cuts.  It was the politically smart thing to do at the time.  Now, it's expedient to repudiate that particular cynical move.  Leaving aside whether or not taxes ought to go up, the process side hacks me off.

As for whether we really SHOULD raise taxes, that's a bit of a loaded question.  I think the underlying premise ought to be that we should be willing to pay for the govenment we have.  Since currently we are running trillion-dollar deficits, either spending should come down, taxes should go up, or a combination.  That much is simple.  And it seems so perfectly reasonable that since one side hates spending cuts and the other hates tax hikes, then splitting the difference and sharing the pain would constitute compromise.

BUT--there is one little detail muddying the waters.  If raising rates resulted in direct increases in revenue, that would make pretty good sense.  But plenty of data exists that tax revenue is far more dynamic than that.  There is a concept called Hauser's Law which suggests that, regardless of rates, the post-WWII USA has never managed to generate more than 19.5% of GDP in taxes.  So it seems like what we ought to do is find the best way to get that optimum revenue (and additionally maximize GDP), while bringing spending to the same level.  That might still mean we can, even should, change our rate structure.  But the notion that we can just confiscate enough cash through taxation to cover spending at current levels doesn't hold much water.  There's also the issue of timing--whether any tax hike, no matter how necessary, would further cripple our fragile economic recovery.  If we lower GDP far enough, even taking 25% (or 30%, or 50%) of it won't make a difference. (And as a matter of math, that's part of our problem right now--we're underperforming Hauser's Law due to the recession we've been in, with spending at about 24% of GDP and revenue in the 15% range.)

I do happen to think we need tax reform.  Perhaps the debt-ceiling debate could include a provision to undertake that in a big way after immediate cuts and an increase in the ceiling happen now.  The current rates WILL revert back to the Clinton levels in 2 years if left alone, after all.  But there's zero chance of getting the kind of reform we need in the next month.  And the reform we need isn't going to be pretty.  The only real way to raise the kind of revenue we really need is to hike taxes on everybody, including the middle class.  Currently nearly half of all taxpayers have zero income tax liability, and the vast majority of total revenue is derived from the very top earners.  Most have heard that the top 1% pay 40% of taxes.  But the top 10% of earners pay about 70% of total taxes, and the top half pay over 95%.  For all the talk of millionaires and billionaires and people who make $250k, we could honestly confiscate every penny those folks earned and still not balance the budget. 

I'm not one of those supply-siders who thinks that every tax cut pays for itself.  I believe that the Laffer Curve is correct--that a zero percent tax yields zero revenue, and that a 100% tax also yields zero revenue (by killing the economic activity being taxed).  And therefore, that if tax rates are "too low," they can be raised to increase revenue--and also that if they are "too high," the reverse should be true.  I don't really think our current top rate of 35% is "too high" if we're talking about maximizing revenue.  (This leaves aside the moral question of whether tax rates should have a moral upper limit.)  But I do not think we can ever solve our fiscal problems without broadening the tax base.

Finally, I'm skeptical of any deal that doesn't cut spending first.  If memory serves, Reagan's big tax cut back in '81 was supposed to be at least partially offset by spending cuts, but the cuts didn't exactly materialize as planned.  Ditto Bush 41 when he broke his "read my lips" pledge in '88.  Even during the Clinton surplus years, the surplus was a combination of increased revenue from the dot-com boom and the "peace dividend" at the end of the Cold War.  But the overall size and cost of government never came down.  (Indeed, the debt never came down, either--but that's another interesting accounting story.)  We all know that taxes can be raised with the stroke of a pen, or even by inertia thanks to current sunset provisions.  What we haven't proven yet is that we are willing or able to cut spending.  So let's do that--eat the veggies first, and then dessert for a change.

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