The Tax Con

Tim Geithner seemed to make it pretty clear today that the administration plans to let the Bush tax cuts for individuals making more than $200,000 and families earning more than $250,000 expire. Here is the rationale for increasing taxes:

“We think that’s the responsible thing to do because we need to make sure we can show the world that (we’re) willing as a country now to start to make some progress bringing down our long-term deficits,” he said on ABC’s “This Week” program.

Notice that he’s justifying the increase as a fiscally responsible policy move. This fits with the larger theme that the administration, much of the MSM and a lot of Democrats are advancing that it is time for Americans to understand that the government has no choice but to pay its ever growing portfolio by claiming a larger share of the nation’s output.

The talk is that 2011 will be the year of major tax overhaul. Supposedly a top to bottom review of the tax code that entails some serious review and reform of embedded subsidies will be paired with the work of increasing the feds take. On the table as well is likely to be the introduction of a value added tax to the menu. It’s all being billed as the inevitable solution to spending commitments arising from entitlement programs.

Let’s step back for a second and consider a couple of things.

First, take a look at this chart from Don Marron:

This actually comes from the CBO and was part of their recently released long-term budget outlook. The blue bars represent tax receipts as a percentage of GDP under current tax law without Congressional meddling while the pink bars assume Congress doesn’t change its stripes and continues to “fix” things like the AMT. Note that the historical tax take has been around 18.2%.

Here are the reasons per Marron that taxes should exceed their historical norm:

That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.

So assuming that we just hold to our present course, federal revenues should grow to levels substantially above historical norms. If spending were to remain somewhere in the historical range of 21% of GDP then we would clearly be running surpluses or at least balancing the budget. We are assured, however, that cannot happen because Social Security and Medicare payments are going to explode and eat up every single tax dollar in sight. Therefore, the only solution is to raise taxes.

Therein lies the con. There is nothing that suggests that both cannot be put on a more sustainable basis but that discussion is excluded from the debate.

Social Security is particularly susceptible to reform. Tweaking the retirement age, fiddling with COLA formulas and some minor means testing will put the program on solid footing. Most of the fixes are politically doable since they can be phased in over a number of years and won’t involve unbearable pain among the electorate.

Medicare and more broadly health care already has its fix in place. It’s Obamacare. While the program doesn’t involve much cost control in its present form, what it does do is make the inevitable “bending of the cost curve” politically easy. Benefits are being bestowed prior to the inevitable austerity that must follow not just to make the program financially feasible but to bring down the share of GDP that health care currently claims. The heavy lifting of rationing and ratcheting down the profit of the health care industry will be at the worst grudgingly accepted as the price that has to be paid to maintain the new benefits (I recommend you read this blog post by Bronte Capital concerning the likely path of cost control). Moreover, Congress has in its unique way created a system that will boot to the bureaucracy the unpleasant job of cutting the cost of health care.

So, we are being marketed a line that suggests the only path to fiscal responsibility is to raise taxes as future expenditures are baked into the cake. In fact, we should be having a discussion that includes increasing revenues, reforming and reducing the impact of entitlements and the desired level of government expenditures overall.

Deficits are wonderful tools for forcing the political class to focus on the bigger picture. Take the pressure off with new revenues and you’re going to give them the out they perpetually seek. Entitlement reform should be a prerequisite for any further discussion much less action with respect to new taxes. Once accomplished then we can move onto a reasoned compromise with regard to the size of the bite the government is going to take from the economy and the uses of those funds.

The one-sided argument that looks to tax increases as the only solution is a confidence game. It’s proponents want to establish a larger, permanent pool of money with which to finance expanded government. Whether that is in the country’s best interests and possible alternatives should be the subject of the debate.

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