Tag: Higher Taxes

Norquist Is Right, Coburn Is Wrong: Tax Increases Undermine Good Fiscal Policy

There’s a significant debate now taking place in Washington — largely behind closed doors, but sometimes covered by the media — on whether fiscal conservatives should maintain a rigid no-tax-increase position. One side of the debate features Grover Norquist of Americans for Tax Reform, which is the organization that maintains the no-tax-increase pledge. The other side features Sen. Tom Coburn of Oklahoma, who is part of a small group of GOP senators who might be willing to increase the tax burden as part of a deal that supposedly reduces deficits.

I’m a huge fan of Senator Coburn, who was in favor of cutting wasteful spending before it became fashionable. His office, for instance, releases a “Pork Report” every couple of days. You shouldn’t read it if you have high blood pressure, because it will confirm (and reconfirm, and reconfirm, ad nauseum) your worst fears about tax dollars getting wasted.

Nonetheless, I’m on Grover’s side on this tax debate, for two reasons.

First, we have a spending problem, not a revenue problem or a deficit/debt problem. Red ink is undesirable, to be sure, but it is a symptom of the underlying problem of a government that is too big and spending too much.

But don’t believe me. Here is a chart from the House Budget Committee showing long-run projections for spending and revenues over the next 70 years. As you can see, the long-run fiscal shortfall is completely caused by higher spending. In other words, 100 percent of red ink is due to government spending. So why put taxes on the table?

But this chart actually understates the case against tax increases. It uses revenue numbers from the Congressional Budget Office’s “alternative” forecast, which shows taxes steady at 19.3 percent of GDP. That’s more than the historical average of about 18 percent of GDP, which surely indicates that revenues are not the problem.

However, that 19.3 percent estimate is completely artificial. As CBO states in its long-run forecast, “the alternative fiscal scenario also incorporates unspecified changes in tax law that would keep revenues constant as a share of GDP after 2020.”

I’ll actually be delighted if we can permanently keep federal revenues below 20 percent of GDP, but I’m not overly optimistic about that because the tax burden is projected to automatically increase over time. And I’m not talking about the expiration of the Bush tax cuts or the broadening of the alternative minimum tax. Yes, those factors would push up tax revenues (at least based on static revenue estimates), but the tax burden also is expected to climb because even modest economic growth slowly but surely pushes more and more people into higher tax brackets.

This second chart shows CBO’s estimate of personal income tax revenue based on current policy (as opposed to estimates based on current law, which includes already-legislated tax hikes). To be more specific, it shows how much revenue the government will collect from the individual income tax even if the 2001 and 2003 tax cuts are made permanent and the AMT is indexed.

As you can see, the aggregate individual income tax burden will increase by roughly 5 percentage points of GDP when compared to the long-run average of about 8 percent of GDP (the CBO estimate only goes to 2035, so I extrapolated to show the same time period as the first chart). And remember, this is the forecast of what will happen to income tax revenues even if politicians don’t impose any new laws to coercively extract more revenue.

This might not be too bad if other taxes were falling, but that’s not what CBO is projecting. As such, this big increase in revenue from the individual income tax means that the overall tax burden will climb by approximately the same amount.

In other words, revenue likely will rise close to 25 percent of GDP as we approach the next century. So if we use this more realistic baseline, we can say that more than 100 percent of the long-run deficit problem is because spending is out of control.

The second reason for a firm no-tax-increase position is that higher taxes are a very ineffective way of reducing budget deficits. Indeed, tax increases generally backfire and lead to more red ink. To understand why, it’s important to put away the calculator and instead consider the real world of politics and public policy. For instance:

  • Tax increases rarely raise as much revenue as predicted by government forecasters. This is because of “Laffer Curve” effects, as taxpayers change their behavior to earn less income and/or report less income. Simply stated, people respond to incentives, and this means taxable income falls as tax rates increase.
  • Tax increases erode pressure to control spending. Why would politicians want to make tough decisions and upset special interest groups, after all, when there is going to be more revenue (or at least the expectation of more revenue)? Using more colloquial language, trying to control spending with higher taxes is like trying to cure alcoholics by giving them keys to a liquor store.
  • Milton Friedman was right when he said that “in the long run, government will spend whatever the tax system will raise, plus as much more as it can get away with.” In other words, if politicians think they can get away with deficits averaging, say, 5 percent of GDP in the long run, then the only impact of higher taxes is an equal amount of additional spending — while still retaining deficits of 5 percent of GDP.

The real-world evidence certainly points in this direction. We’ve seen “bipartisan budget summits” several times in Washington, and the result is more spending rather than lower deficits. Americans for Tax Reform has a good analysis of what happened after the two big budget summits in 1982 and 1990, but I think the problem is best captured by my adaptation of a famous Peanuts cartoon strip.

Every year, if my aging memory is correct, Lucy would ask Charlie Brown if he wanted to kick the football. At first, Charlie was skeptical. But Lucy always managed to trick him into giving it a try. And the inevitable result was Charlie Brown lying on his back wondering why he had been so foolish.

In the Washington version of this cartoon, Democrats hypnotize gullible Republicans with ostensibly sincere promises of future spending restraint. Republicans eventually acquiesce, naively assuming that Democrats will be their new BFFs in the fight against big government.

Needless to say, that’s not the way the story ends.

Ronald Reagan is reported to have said that the 1982 tax increase was the “biggest mistake” of his presidency. And since Congress never followed through on commitments to reduce spending by $3 for every $1 of higher taxes, he wryly remarked that “I’m still waiting on those three dollars of spending cuts I was promised from Congress.”

Like Reagan, Coburn wants to do the right thing. But good intentions are not the same as good policy. America’s fiscal challenge is too much spending. Government is too big and it is wasting too much money. Taking more money from the American people is not the way to solve that problem.

Deconstructing the Revenue Side of Obama’s Budget

I looked yesterday at the spending side of Obama’s budget and found some good news and bad news. The good news was the absence of any big new initiative to expand the burden of government. That’s a welcome relief since the past couple of years have featured budget busting proposals such as the so-called stimulus scheme and a government-run healthcare plan.

The bad news is that the budget does nothing to undo any of the damage of the past two years. Nor does it undo any of the damage of the previous eight years. And because the President’s budget refuses to address entitlement spending, it certainly doesn’t do anything to avert the damage of rapidly expanding budgets over the next several decades.

Now let’s look at the tax side of the fiscal equation. In large part, the White House is recycling class warfare ideas from last year’s budget. The President wants higher tax rates, including higher taxes on investors, entrepreneurs, and small business owners. He also wants to increase the tax burden of American companies that are competing for market share in global markets.

These are remarkably misguided proposals. But what’s especially disappointing is that the Administration stuck with these bad ideas when the President’s own fiscal commission proposed lower tax rates and base broadening. Those proposals would have increased the overall tax burden, so they definitely were not pure supply-side economics. And the Commission also proposed an increase in the double taxation of saving and investment, which also would be unfortunate.

But at least the Commission proposed to do the wrong thing in a good way. Yes, taxes would have increased, but the damage would have been ameliorated by a better tax structure. Obama’s budget, by contrast, does the wrong thing in the worst way - increasing the tax burden while also making the tax system more unfair.

It’s also worth noting that the President decided to punt on the issue of corporate tax reform. This is remarkable since even he acknowledged during his State-of-the-Union address that America’s corporate tax rate is far too high in a competitive global economy.

Last but not least, it’s worth noting that Obama’s budget shows that tax revenues will rise above their long-run average of 18 percent of GDP - even if taxes are not increased by one penny.

America’s budget problem is too much spending, period.

Obama the Born-again Budget Cutter?!?

Chalk up another victory – at least on the rhetorical level – for the Tea Party.

President Obama will release his fiscal year 2012 budget tomorrow and he’s apparently become a born-again fiscal conservative. Here are some excerpts from a Washington Post story:

President Obama will respond to a Republican push for a drastic reduction in government spending by proposing sharp cuts of his own in a fiscal 2012 budget blueprint that aims to trim record federal deficits by $1.1 trillion over the next decade. …two-thirds of the savings would come from spending cuts that are draconian by Democratic standards… When it lands Monday on Capitol Hill, Obama’s plan will launch a bidding war with Republicans over how deeply and swiftly to cut, as the two parties seek a path to fiscal stability for a nation awash in red ink.

I’m skeptical of battlefield conversions, particularly when politicians utilize the dishonest Washington definition of a budget cutincreasing spending by less than previously planned. So the first thing I’ll do when the budget is released is to visit the Historical Tables of the Budget website and see what spending is projected to be in 2011 and what Obama is asking for in 2012.

Those numbers probably won’t be accurate since the Obama administration (like previous ones) will use best-case assumptions, but at least we’ll get a sense of whether:

a) spending actually is being cut (I’m not holding my breath for this miracle), or

b) spending is frozen at current levels (this approach would balance the budget by 2017, but it’s almost as unlikely at the first option), or

c) spending is being restrained (perhaps 2 percent growth, enough to keep pace with inflation), or

d) spending is growing far too fast (say 4 percent growth, pushing America quickly in the wrong direction), or

e) spending is continuing to explode (5 percent growth, 6 percent growth, or even more, meaning we’ll be Greece sooner than we think).

My guess, for what it’s worth, is that the Obama administration will claim (d) but will actually be proposing (e) if more realistic assumptions are used.

Needless to say, I hope I’m wrong. But other parts of the Washington Post story give me little reason for hope. The White House apparently is ignoring entitlements. Heck, the administration apparently isn’t even planning on meeting the President’s own deficit goal.

The blueprint ducks the harder task of tackling the biggest drivers of future deficits: Social Security, Medicare and Medicaid… Obama’s blueprint does not even hit the short-term goal he set for his commission - reducing deficits to 3 percent of the economy by 2015.

The White House also plans to play a shell game with certain parts of the budget. Supposed spending cuts in health care won’t generate taxpayer savings. Instead, they’ll be used to finance more spending on Medicare, enabling the President to cancel savings that were promised as part of Obamacare. The interest groups win and the taxpayers lose.

The Obama blueprint also seeks to eliminate two budget gimmicks that Congress has long used to mask the true depth of the red ink: His proposal would offset higher Medicare payments to doctors by cutting $62 billion from other areas of federal health spending. And it would adjust the alternative minimum tax through 2014 to prevent it from hitting middle-class taxpayers, covering the cost by limiting the value of itemized deductions such as charitable contributions and mortgage interest for wealthy households.

The same shell game takes place on the tax side of the fiscal ledger. The White House plans to cancel one future tax increase and “pay” for that change by imposing another future tax increase. Once again, taxpayers get the short end of the stick.

Unless the Washington Post story is completely inaccurate, the Obama administration is not changing course. There may not be any major initiatives to expand the burden of government, like the failed stimulus or the budget busting government-run healthcare scheme, but it certainly does not seem like there are any plans to reverse direction and shrink the burden of government.

The 1993 Clinton Tax Increase Did Not Lead to the Budget Surpluses of the Late 1990s

Proponents of higher taxes are fond of claiming that Bill Clinton’s 1993 tax increase was a big success because of budget surpluses that began in 1998.

That’s certainly a plausible hypothesis, and I’m already on record arguing that Clinton’s economic record was much better than Bush’s performance.

But this specific assertion it is not supported by the data. In February of 1995, 18 months after the tax increase was signed into law, President Clinton’s Office of Management and Budget issued projections of deficits for the next five years if existing policy was maintained (a “baseline” forecast). As the chart illustrates, OMB estimated that future deficits would be about $200 billion and would slightly increase over the five-year period.

In other words, even the Clinton Administration, which presumably had a big incentive to claim that the tax increase would be successful, admitted 18 months after the law was approved that there was no expectation of a budget surplus. For what it’s worth, the Congressional Budget Office forecast, issued about the same time, showed very similar numbers.

Since the Clinton Administration’s own numbers reveal that the 1993 tax increase was a failure, we have to find a different reason to explain why the budget shifted to surplus in the late 1990s.

Fortunately, there’s no need for an exhaustive investigation. The Historical Tables on OMB’s website reveal that good budget numbers were the result of genuine fiscal restraint. Total government spending increased by an average of just 2.9 percent over a four-year period in the mid-1990s. This is the reason why projections of $200 billion-plus deficits turned into the reality of big budget surpluses.

Republicans say the credit belongs to the GOP Congress that took charge in early 1995. Democrats say it was because of Bill Clinton. But all that really matters is that the burden of federal spending grew very slowly. Not only was there spending restraint, but Congress and the White House agreed on a fairly substantial tax cut in 1997.

To sum things up, it turns out that spending restraint and lower taxes are a recipe for good fiscal policy. This second chart modifies the first chart, showing actual deficits under this small-government approach compared to the OMB and CBO forecasts of what would have happened under Clinton’s tax-and-spend baseline.

Four Reasons Why Big Government Is Bad Government

A new video from the Center for Freedom and Prosperity gives four reasons why big government is bad fiscal policy.

I particularly like the explanation of how government spending undermines growth by diverting labor and capital from the productive sector of the economy.

Some cynics, though, say that it is futile to make arguments for good policy. They claim that politicians make bad fiscal decisions because of short-term considerations such as vote buying and raising campaign cash and that they don’t care about the consequences. There’s a lot of truth to this “public choice” analysis, but I don’t think it explains everything. Maybe I’m an optimist, but I think we would have better fiscal policy if more lawmakers, journalists, academics, and others grasped the common-sense arguments presented in this video.

And even if the cynics are right, we are more likely to have good policy if the American people more fully understand the damaging impact of excessive government. This is because politicians almost always will do what is necessary to stay in office. So if they think the American people are upset about wasteful spending and paying close attention, the politicians will be less likely to upset voters by funneling money to special interests.

For those who want additional information on the economics of government spending, this video looks at the theoretical case for small government and this video examines the empirical evidence against big government. And this video explains that America’s fiscal problem is too much spending rather than too much debt (in other words, deficits are merely a symptom of an underlying problem of excessive spending).

Last but not least, this video reviews the theory and evidence for the “Rahn Curve,” which is the notion that there is a growth-maximizing level of government outlays.

New CBO Numbers Re-Confirm that Balancing the Budget Is Simple with Modest Fiscal Restraint

Many of the politicians in Washington, including President Obama during his State of the Union address, piously tell us that there is no way to balance the budget without tax increases. Trying to get rid of red ink without higher taxes, they tell us, would require “savage” and “draconian” budget cuts.

I would like to slash the budget and free up resources for private-sector growth, so that sounds good to me. But what’s the truth?

The Congressional Budget Office has just released its 10-year projections for the budget, so I crunched the numbers to determine what it would take to balance the budget without tax hikes. Much to nobody’s surprise, the politicians are not telling the truth.

The chart below shows that revenues are expected to grow (because of factors such as inflation, more population, and economic expansion) by more than 7 percent each year. Balancing the budget is simple so long as politicians increase spending at a slower rate. If they freeze the budget, we almost balance the budget by 2017. If federal spending is capped so it grows 1 percent each year, the budget is balanced in 2019. And if the crowd in Washington can limit spending growth to about 2 percent each year, red ink almost disappears in just 10 years.

These numbers, incidentally, assume that the 2001 and 2003 tax cuts are made permanent (they are now scheduled to expire in two years). They also assume that the AMT is adjusted for inflation, so the chart shows that we can balance the budget without any increase in the tax burden.

I did these calculations last year, and found the same results. And I also examined how we balanced the budget in the 1990s and found that spending restraint was the key. The combination of a GOP Congress and Bill Clinton in the White House led to a four-year period of government spending growing by an average of just 2.9 percent each year.

We also have international evidence showing that spending restraint - not higher taxes - is the key to balancing the budget. New Zealand got rid of a big budget deficit in the 1990s with a five-year spending freeze. Canada also got rid of red ink that decade with a five-year period where spending grew by an average of only 1 percent per year. And Ireland slashed its deficit in the late 1980s by 10 percentage points of GDP with a four-year spending freeze.

No wonder international bureaucracies such as the International Monetary fund and European Central Bank are producing research showing that spending discipline is the right approach.

This video provides all the details.

Will the Last Person to Leave Illinois Please Turn Off the Lights?

There is a very bizarre race happening in Illinois. The Governor and the leaders of the State Senate and General Assembly are trying to figure out how to ram through a massive tax increase, but they’re trying to make it happen before new state lawmakers take office tomorrow. The Democrats will still control the state legislature, but their scheme to fleece taxpayers would face much steeper odds because of GOP gains in last November’s elections.

As a result, the Illinois version of a lame-duck session has become a nightmare, sort of a feeding frenzy of tax-crazed politicians. Here’s the Chicago Tribune’s description of the massive tax hike being sought by the Democrats.

The 3 percent rate now paid by individuals and families would rise to 5 percent in one of the largest state tax increases in Illinois history. …Also part of the plan is a 46 percent business tax increase. The 4.8 percent corporate tax rate would climb to 7 percent… In addition, lawmakers are looking at a $1-a-pack increase in the state’s current 98-cent tax on cigarettes. …Democrats will still control the new General Assembly that gets sworn in Wednesday, their numbers were eroded by Republicans in the November election. With virtually no Republican support for higher taxes, Democratic leaders contend it will be easier to gain support for a tax hike in a legislature with some retiring members no longer worried about facing the voters.

If Governor Quinn and Democratic leaders win their race to impose a massive tax hike, that will then trigger another race. Only this time, it will be a contest to see how many productive people “go Galt” and leave the state. John Kass, a columnist for the Tribune, points out that the Democrats’ plan won’t work unless politicians figure out how to enslave taxpayers so they can’t escape the kleptocracy known as Illinois.

The warlords of Madiganistan — that bankrupt Midwestern state once known as Illinois — are hungry to feed on our flesh once again. This time the ruling Democrats are planning a…state income tax increase, with more job-killing taxes on corporations… A few tamed Republicans also want to join in and support a tax deal, demonstrating their eagerness to play the eunuch in the court of the pasha. And though they’ve been quite ingenious, waiting for the end of a lame-duck legislative session to do their dirty work, they forgot something important. They forgot to earmark some extra funds for that great, big wall. You know, that wall they’re going to need, 60 feet high, the one with razor wire on top and guard towers, equipped with police dogs and surrounded by an acid-filled moat. The wall they’re going to have to build around the entire state, to keep desperate taxpayers from fleeing to Indiana, Wisconsin and other places that want jobs and businesses and people who work hard for a living. …With the state billions upon billions in debt, and the political leaders raising taxes, borrowing billions more and not making any substantive spending cuts, we’ve reached a certain point in our history. The tipping point. Taxes grow. Employers run. The jobs leave. High-end wage earners have the mobility to escape. What’s left are the low-end workers who are stuck here. …the Democrats aren’t about to disappoint their true constituents. So they don’t cut, they tax. Because the true constituents of the Democratic warlords are the public service unions and the special interests that benefit from all that spending. Why should politicians make cuts and anger the people that give them power, the power that allows them access to treasure? …we reach another tipping point: The point at which those who are tied to government, either through contracts or employment, actually outnumber those who are not tied to government. Do the math on Election Day.

Illinois is America’s worst state, based on what it costs to insure state debt. The greedy politicians in Springfield think a tax hike will give them enough money to pay bondholders and reward special-interest groups. But that short-sighted approach is based on the assumption that people and businesses will cheerfully bend over and utter the line made famous by Animal House: “Thank you, sir! May I have another?”

Moving across state lines is generally not something that happens overnight. But this giant tax hike is sure to be the tipping point for a few investors, entrepreneurs, rich people, and employers. Each year, more and more of them will decide they can be more successful and more profitable by re-domiciling in low-tax states. When that happens, Illinois politicians will get a lesson about the Laffer Curve, just as happened in Maryland, Oregon, and New York.