The Real Budget Problem

Tax increases won’t solve our budget woes.

Michael Tanner
Wednesday, June 15, 2011

If you listen to the discussion of the deficit in the mainstream media or the talking points from leading Democrats on the Hill (but I repeat myself), the refrain is that tax increases must be part of any deficit fix.

There is a superficial moderation to that appeal, a sort of splitting the difference between Republicans who want to cut spending and Democrats who want to pay for popular programs. And, frankly, some tax breaks and loopholes should be eliminated — ethanol subsidies, for example — not as revenue raisers, but because they are such bad economic policies.

But raising taxes to reduce the deficit would be bad policy for several reasons:

There’s not really a revenue problem. Democrats correctly point out that federal tax revenues are now just 16.5 percent of GDP, well below the post–World War II average of roughly 18 percent. This would have meant a bigger budget deficit than usual even if spending hadn’t exploded in recent years. But much of that decline is due to the economic slowdown, not to the Bush tax cuts or other policy changes. In fact, the Congressional Budget Office predicts that as economic growth returns, federal tax revenues will grow by an average of 7.3 percent annually over the next ten years. By the end of the decade, taxes will have pushed back through the 18 percent level, and be headed toward 20 percent — all without any changes in tax policy.

There is a spending problem. Focusing on taxes implies that the problem is how to pay for spending — taxes or debt — not the spending itself. But, as Milton Friedman constantly pointed out, the real cost of government is the size of government. According to the CBO, the federal government is on track to consume 42 percent of GDP by 2050. (State and local governments will consume another 10 to 15 percent of GDP.) Would we really be better off if we raised taxes enough to pay for all that spending?

You can’t tax enough. The president keeps talking about solving our deficit problems by taxing millionaires and billionaires. Congressional Democrats throw in oil companies. But you could confiscate — not tax, confiscate — every penny belonging to every millionaire in America and cover barely one-tenth of our government’s total indebtedness (including the unfunded liabilities of Social Security and Medicare). Meanwhile the tax breaks for oil and gas companies amount to about $1.4 billion annually. Those tax breaks may or may not be defensible, but they amount to less than 1 percent of this year’s budget deficit.

Bait and switch. If you look at most of the deficit-cutting proposals, including the president’s, they call for tax increases today in exchange for spending cuts somewhere in the future. I think we’ve seen that movie before. In fact, the president’s proposal actually makes the bait-and-switch game worse. His proposal says that if Congress didn’t actually make those spending cuts, there would be additional tax increases. So Republicans would be agreeing to tax increases today in exchange for . . . more tax increases tomorrow.

Tax hikes are bad for the economy and for freedom. Of course it’s an exaggeration to suggest that all tax cuts pay for themselves, but there is no doubt that high taxes discourage the type of investment and risk-taking necessary to grow the economy and create jobs. Every dollar that the federal government takes in taxes is one less dollar that the private sector can save, invest, or spend as it sees fit. Unless you believe that the government knows better than the private sector what to do with that money, this exchange hurts the economy. And unless you believe that our money really belongs to the government, it means we are less free to make use of the fruits of our labor as we see fit.

Republicans should not fall into the trap of reflexively defending every special-interest loophole in the tax code. But neither should they be seduced by the argument that we need a “balanced” approach to deficit reduction that includes tax increases. Government is too big, too intrusive, and too expensive. It doesn’t take more taxes to fix that.