Politics & Policy

The Budget Battle

Significant tax increases would kill the American economy.

What’s more confused, the Obama administration’s Middle East policy or its economic policy? Really kind of a pick-’em situation. While the Syrian befuddlement is more in the headlines right now, the brewing battle over the budget and the debt ceiling will soon remind America of the White House’s illogical obsession with more federal tax increases despite a glacial economic recovery. As Treasury Secretary Jack Lew recently told CNBC, “The president made clear he was prepared to do tough things on entitlement programs, but those tough actions on entitlement programs require balance in terms of revenue both for fairness and . . . for economic results.”

So in the end President Obama’s insistence on even more tax hikes will block major structural reform in Medicaid, Medicare, and Social Security. But as with possible limited strikes on the murderous Syrian regime, what’s the endgame here? In his most recent budget, Obama called for nearly $1 trillion in new tax increases, scored over ten years. The proposed hikes include a cap on deductions for wealthier taxpayers and the “Buffett Rule,” a 30 percent minimum tax rate on million-dollar earners who have lots of investment income.

Now that’s a dead-on-arrival proposal, of course. But what if it weren’t? Actually, let’s go even further. Let’s give Obamacrats the sort of tax hikes Obama and Harry Reid and Nancy Pelosi could only fantasize about. Let’s really pile the tax increases on the rich and near-rich by raising (a) the top ordinary income tax rate to 50 percent and the next two tax brackets to 41 percent and 39 percent, (b) the top tax rate on capital gains to 40 percent, and (c) the Social Security payroll tax cap to $170,000 and letting it rise with wage growth.

Altogether, according to a Third Way study, these increases would collect $3.5 trillion over ten years, with federal revenue as a share of GDP rising from 19 percent in 2014 to 23 percent in 2040, averaging 21 percent of GDP over that period. By contrast, revenue as a share of GDP averaged a bit more than 17 percent over the past four decades. Yet despite a whopping 30 percent increase in long-term tax revenue, the national debt as a share of output would still double, with annual budget deficits topping $3 trillion a year as entitlement-driven spending topped 30 percent of GDP.

To keep deficits at roughly 3 percent of GDP between now and 2040 without entitlement reform, revenue by 2040 would have to reach at least 27 percent of GDP. Here’s how you might achieve that, according to Third Way: Increase all tax rates on ordinary income by 5 additional percentage points and rates on capital gains by 10 percentage points. Oh, and one additional thing: Impose a 10 percent national value-added tax. Taken all together, these tax hikes would amount to a 60 percent tax increase on the median-income family, raising its annual tax burden by $6,200, in 2012 dollars.

And remember that all this assumes no impact on economic growth. But that seems unlikely, given starkly higher marginal tax rates on labor and capital income, not to mention a far larger overall tax burden. If there’s a recipe for economic stagnation and decline, you’ve just read it. As it is, keeping the future U.S. tax burden to anywhere near the historical average — sorry, advocates of a 15 percent flat tax — will take an extreme makeover of America’s safety net. And the sooner that major remodeling project begins, the less radical it will need to be and the less taxes will need to be raised. But with no major policy changes, Obama will leave office with the entitlement tsunami fast approaching and no realistic amount of tax hikes sufficient to prevent it from swamping the U.S economy. If the president really cares about the American middle class and economic mobility, it’s time for him to sketch what an endgame of abundance rather than scarcity would look like.

— James Pethokoukis, a columnist, blogs for the American Enterprise Institute. 

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