The country is on an unsustainable fiscal path. According to the Congressional Budget Office’s alternative scenario (the one that makes realistic assumptions about future policies), by 2050 the national debt will reach 344 percent of the economy with Medicare and Medicaid consuming half the budget.
And yet, the deficit commission is unlikely to recommend a reform of the entitlement programs, whether health care or social security. This is why I have no faith in its recommendations.
What they might recommend, however, are solutions to address what the New York Times calls our “inadequate tax revenues.” According to the Wall Street Journal, the commission is targeting $1 trillion in tax breaks such as the mortgage-interest deductions and the child tax credits:
At stake, in addition to the mortgage-interest deductions, are child tax credits and the ability of employees to pay their portion of their health-insurance tab with pretax dollars. Commission officials are expected to look at preserving these breaks but at a lower level, according to people familiar with the matter.
Americans for Tax Reform has found that the net effect of closing these tax breaks would be a $2.4 trillion tax hike over the next five years.
We have a spending problem, not a revenue problem. However, I am very much in favor of fundamental tax reform. Hence, I would be in favor of broadening the tax base and doing away with many of the distortions brought about by tax breaks and special tax favors. But the endorsement comes with a warning: broadening the base alone won’t do the country’s fiscal outlook any good. That’s because it would be the equivalent of a company going out of business deciding to raise its prices hoping that things get better. Things wouldn’t — in fact, things would get worse.
The economics here is quite simple: what you need to generate tax revenue is a thriving economy. Taxing something means raising its cost, and raising its cost means that you will get less of it. If the government taxes the economy heavily, it will slow the growth that it needs to generate tax revenue. That’s why you can’t tax your way out of it.
It means that the broadening of the tax base should be paired with serious cut in marginal tax rates. James Pethokoukis reports in Reuters this morning that “cutting the total amount of tax expenditures by half might allow the top income tax rate to be cut from 35 percent to 25 percent. That is what you want in an ideal, pro-growth tax system: low rates applied to a broad base.” That would be a great idea, but I’m afraid that the rate cuts won’t be part of the deficit commission’s recommendations.
I wish more pundits, lawmakers, and advisers would remember the following: Reality isn’t negotiable. In this case, it means that no matter how appealing raising tax revenue to address the current crisis sounds, it won’t work. Since World War II, successive governments have tried to increase taxes to get more revenue. Some have broadened the tax base and others have increased marginal tax rates, but all of them have failed each time they have tried. The government has never been able to jack up revenue as a percentage of GDP above the historical average of 19 percent except for very short periods of time. If it’s never happen before, in spite of many attempts to raise taxes, there is no reason to think that it will ever happen.