Misreading the Fiscal Cliff
No one, including Republicans, is focusing on the right issues.


Michael Tanner

The fiscal cliff is now less than six weeks away. Negotiators are reportedly locked away behind closed doors working on a grand bargain to avoid the tax hikes and spending cuts that will hit on January 1. Most of the debate so far has centered on how best to raise taxes on the wealthy: whether to increase tax rates, as the president demands, or eliminate deductions and loopholes, as some Republicans seem to be open to considering. Unfortunately, these priorities are almost entirely upside down.

Therefore, let me offer some unsolicited advice for the negotiators:

You can’t hike taxes on the rich enough to balance the budget. President Obama has called for $1.6 trillion in tax hikes over the next ten years. While that is large enough to do serious damage to the economy, it would amount to just 16 percent of the combined deficits that we are projected to face over that period. In fact, the president’s proposed tax hike doesn’t even cover the $2.6 trillion in spending increases that he has called for over the next ten years. Obamacare alone will add $2.15 trillion in federal spending by 2022.

Worse, none of this accounts for the rapidly accumulating unfunded liabilities of Social Security and Medicare. Washington tends to focus on our $1.1 trillion budget deficit or our $16.2 trillion national debt, but our real debt, including those unfunded liabilities, is somewhere between $78.5 and $128.2 trillion. As I have pointed out before, you could confiscate — not tax but confiscate — every penny belonging to every millionaire and billionaire in America, and still not have anywhere near enough money to pay for all that we owe.

Of course, even these estimates assume that hiking taxes will actually generate more revenue. It is worth noting, for instance, that Great Britain hiked its top tax rate from 40 to 50 percent in 2010 as part of a deficit-reduction package. The tax hike was supposed to raise an additional £2.4 billion in 2010–11, but actually brought in £5 billion less than was expected without the rate rise (Britain cut tax rates again in the 2012 budget). This should be no surprise. Not all tax cuts pay for themselves (as some Republicans mistakenly believe), but there is a limit to how much taxes can be raised before they begin to create disincentives for work, saving, and investment that prove counterproductive. For example, Veronique de Rugy, a senior research fellow at the Mercatus Center and an NRO contributor, has pointed out that revenue as a percentage of GDP has held relatively constant over the past 80 years regardless of the top marginal tax rate.

Arguing about what taxes should be raised is a distraction from the real issues.

That’s because we have a spending problem. As my colleague Dan Mitchell points out, all that is necessary to balance the federal government’s budget is for government spending to grow more slowly than the economy as a whole. In fact, the Congressional Budget Office predicts that even without any tax hikes, government revenue will reach 21.4 percent of GDP by 2022, significantly higher than its postwar average. Why, then, will we still have a deficit? Because spending that year is expected to exceed 22 percent of GDP, compared with a post-war average of 19.8 percent, and just 18.3 percent as recently as Bill Clinton’s presidency.

According to the CBO, even if we never add another government program, federal spending will reach 46 percent of GDP by mid-century. True, some of that spending is interest on an ever-rising debt, but even if one assumes that the government had no interest expenses beyond those on the $16.2 trillion it currently owes, federal-government spending would still approach 30 percent of GDP by 2050. There is no possible way to raise taxes enough to pay for that amount of spending without wrecking the economy.

President Obama claims that his plan includes spending cuts — in fact, $3 in spending cuts for every $1 in tax hikes. But he hasn’t actually offered any details beyond smoke and mirrors. The president’s plan, for example, includes $1 trillion in spending cuts that were already agreed to as part of the 2011 debt-ceiling deal, a neat exercise in double-counting. He also includes savings from not fighting a war in Iraq or Afghanistan after 2014, money that was never going to be spent in the first place. And, finally, he includes $634 billion in savings from not having to pay interest on the phantom spending he’s cut. More realistic estimates suggest that the president is actually proposing almost $3 in tax hikes for every $1 in spending cuts.

Even those spending cuts are not real cuts, in the sense of less money being spent, but simply reductions in the baseline rate of increase. And while the president’s proposed tax hikes would go into effect immediately, the spending cuts are pushed off into the dim and distant future. In fact, according to recent reports, the president actually wants new stimulus spending in the short term, to be followed by spending cuts once the economy has bounced back.