During his brief media appearance on Monday responding to S&P’s downgrade of the U.S. credit rating and the subsequent stark market plunge, Pres. Barack Obama once again renewed his call for a “balanced approach” to debt reduction, combining modest entitlement reform with tax increases. This was the same formulation repeated endlessly by the president, Democrats in Congress, and much of the media throughout the recent negotiations over raising the debt ceiling.
But beyond raw ideology, there is no reason to believe that coupling tax hikes with spending cuts would solve our debt problems.
President Obama usually couches his call for tax hikes in terms of fairness. How, he asks, can we cut programs that help people without also asking the wealthy to “sacrifice” something as well? Setting aside the fact that this formulation establishes a false moral equivalence between giving less to people who have not earned it and taking more from the people who have, this ignores the fact that the wealthy in America already pay a disproportionate share of taxes.
The richest 1 percent of Americans earn 20 percent of all income in America but pay 38 percent of income taxes. The top 5 percent earn slightly more than one-third of U.S. income while paying nearly 59 percent of income taxes. At the same time, roughly half of Americans pay no federal income tax. One might suggest, therefore, that the wealthy already pay their fair share, and then some.
Of course other taxes, such as payroll taxes, property taxes, sales taxes, and the like, tend to be more regressive. But even if you include all types of federal, state, and local taxes, the wealthy pay a considerably higher proportion of taxes than their share of income would warrant.
Others less prone to moral posturing argue for including tax hikes along with spending reductions on the grounds that it is “impossible to balance the budget through cuts alone.” But the evidence strongly suggests that cutting spending alone may be the only way to really balance the budget. Indeed, by including tax hikes, we slow economic growth, thereby making it harder to balance the budget.
Simply look to those European countries today that have adopted such a “balanced” approach to debt reduction. Britain, Greece, Portugal, and Spain have all included major tax hikes as part of their austerity packages. The result across the board has been anemic economic growth and scant progress toward debt reduction. Britain, for instance, imposed a new 50 percent top income-tax rate, hiked the capital-gains tax rate from 18 percent to 28 percent, and increased the VAT rate from 17.5 percent to 20 percent. The result: During the first quarter of 2011, the British economy grew at just 0.5 percent, barely enough to offset the 0.5 percent decline during the last quarter of 2010.
Paul Krugman and others have argued that it was the spending cuts, not the tax hikes, that slowed economic growth. Others more plausibly have suggested that the continuing shocks that are buffeting the world economic system have reduced economic growth generally and made it difficult to judge the effectiveness of any particular policy or group of policies.
But the body of evidence from outside the current economic crisis tends to confirm the hypothesis that additional taxes would slow economic growth, making it harder to reduce the debt. For example, a study by Harvard economists Alberto Alesina and Silvia Ardagna looked at more than 100 debt-reduction efforts in 21 countries between 1970 and 2007. They found that a combination of spending cuts and revenue reductions was actually more likely to result in debt reduction than a combination of spending cuts and revenue increases.
History shows us that countries as divergent as Canada, Ireland, New Zealand, and Slovenia successfully reduced the size of their governments relative to their economies and lowered their debt burden substantially. They did so by controlling spending, not by raising taxes.
In this country, look to the end of World War II. The U.S. government cut spending by nearly two-thirds, from $84 billion in 1945 to just $39 billion in 1946. While the country ran a budget deficit of nearly 21 percent of GDP in 1945, it was running a surplus by 1947. At the time, many economists predicted that cuts of that magnitude would destroy the U.S. economy and bring about Depression-era levels of unemployment. Instead, civilian employment actually grew, and an era of economic expansion began that would last throughout the 1950s.
All this implies that we should find a way to cut spending. And that brings us back to President Obama’s press briefing. At the end of his remarks, the president once again laid out his plans for the future, and called for more spending: more spending on education, more spending on unemployment insurance, more spending for an infrastructure bank, more, more, more.
Perhaps that, and not a mythical “balance,” is what really lies behind his calls for higher taxes.