The Corner

What Is a Tax Increase?

That’s the important question that James Carter and Jason Fichtner are asking in this Investors Business Daily piece.

Consider the problem facing House Republicans. With the federal government bumping up against its debt limit, Republicans are demanding that any increase in the limit be paired with equally large spending cuts. As a matter of principle, they have ruled out raising taxes. This elicits the nettlesome question, “What constitutes a tax increase?”

Good question, especially in light of the recent infighting over the elimination of the ethanol tax credit. I have to say, I have been wondering recently what the concept of a revenue-neutral bill means these days. Tax revenue is roughly 14 percent of GDP — is that the baseline? Or is it the historical average of 18 percent? Or is it the CBO’s projected tax collection? Or the OMB one? Carter and Fichtner add some questions to mine:

Is trimming a federal spending program that happens to reside in the tax code a tax increase?

What about proposals to index the federal tax code using a more accurate measure of inflation? Congress indexed the income tax in the early 1980s to prevent inflation from pushing taxpayers into increasingly higher tax brackets as their nominal incomes (but not their real incomes) increased with inflation.

The only problem is that the current system of indexation is widely thought to overstate inflation. CBO estimates switching to a system of indexation that more accurately measures inflation would generate $86.9 billion in additional federal tax revenue over the coming decade. Is switching to a more accurate measure of inflation a tax increase?

When Congress lowered the tax rate on long-term capital gains to 15% from 20% in 2003, capital gains realizations surged as people sought to take advantage of the lower rate. Federal revenue from capital gains taxes ($109 billion in 2006 vs. $58 billion in 2002) surged as well. Did that constitute a tax increase?

Similarly, is it a tax increase when well-designed revisions to tax policy spur economic growth and, as a consequence of that growth, generate additional tax revenue? This isn’t to say that all tax cuts pay for themselves. (Most don’t.) But taxes change incentives and influence behavior.

Reducing marginal tax rates can improve the incentive to work, save and invest — and the positive impact on economic growth will result in either a smaller-than-expected revenue loss or, in select cases, an outright increase in overall tax revenue. The point is it cannot be said that an increase in tax revenue is proof of a tax increase.

Their answer is that while we are fighting over the question of what is a tax increase, we are not focusing on fixing our tax system. Our tax code is broken, unfair, and inefficient from the tax collectors’ and taxpayers’ point of view. That’s what we should focus on.

The real debate should be focused on advancing reform that encourages saving, investment and job creation, while further removing biases against work.

It should not be surprising that Congress is having trouble grappling with these issues. As Groucho Marx also commented: “Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.”

They have a point. 

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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