On Friday, I mentioned several deep flaws with the deficit commission’s plan to address our debt problem. The biggest one, of course, is that it doesn’t address the entitlement-spending explosion, hence it doesn’t address the debt crisis (see Yuval’s excellent comments on this point here). Also, the commission’s plan increases spending by $1.6 trillion between today and 2020.
To continue outlining the plan’s flaws, I’ll also point out that the deficit commission’s plan for revenue collection is nothing more than wishful thinking. As the following chart shows, it relies on being able to collect tax revenue at 21 percent of GDP for the foreseeable future. But collecting 21 percent of GDP in tax revenue is something the federal government has never managed to accomplish. The last time it came close to raising 21 percent of GDP was in 1944, when it collected 20.9 percent — for one year only. In 2000, the federal government came close to the 21 percent mark but stopped at 20.6 percent of GDP. Maybe more importantly, the Congressional Budget Office’s alternative baseline shows that a more realistic assumption about tax revenue is 19.3 percent of GDP, not 21 percent.
There are many reasons why the federal government’s ability to raise revenue is limited. One reason is that when taxes go up, some people change their behavior, reducing their labor supply to adjust to the new cost of working. Another important reason is politics. It seems that politicians themselves understand that they shouldn’t raise taxes too much, so they often raise the tax rates but extend exemptions that shrink the tax base. Or maybe it’s just that they want to raise taxes but also want to keep interest groups happy, which leads them to basically take with one hand and give things like tax credits with the other.
Whatever the reasons for the above trend in tax revenue (and I’m sure there are many), it means that any solution to our budget problems should rest on cutting spending, not raising taxes.
But we wanted to show that balancing the budget without raising taxes is totally doable. It only requires that we cut $128 billion every year in projected spending growth. We’re not even talking about cutting spending from the current level. What’s more, we assumed that interest on the debt stays at its current level, which would be very pessimistic in a scenario where, in fact, spending grew at a slower rate. We ended up at the current level of spending, $3.6 trillion, as opposed to the deficit commission’s projected level of $5 trillion.
Of course, in our example we assume, like the CBO alternative does, some increases in tax revenue from the current level of 14.9 percent of GDP. But the increase we assume is the result of economic growth rather than tax increases. That being said, the revenue increase won’t materialize if the economy doesn’t recover — and increasing taxes won’t help in today’s environment.