As congressional leaders and the White House begin to negotiate on the fiscal cliff we are hearing a lot about raising taxes on the “rich.” The debate has morphed from whether or not to tax the rich to how to tax the rich. Apparently, a majority of Americans bought into the President’s dubious campaign pitch about taxing millionaires and billionaires to solve the budget crisis. And based on the media’s coverage of the fiscal cliff—they did too. That’s a shame, because America doesn’t have a revenue problem. It has a spending problem.
You don’t have to be a budget wonk to recognize that it is profligate government spending—and not low taxes—that is the problem. As the President is fond of saying, it is just arithmetic.
Pre-Obama, federal spending averaged 19.9% of GDP and federal revenue averaged 17.6% of GDP. That still leaves a modest deficit, but a deficit equal to 2.3% of GDP is sustainable. To get back to a sustainable budget, a deal on the fiscal cliff should target federal spending of about 20% and federal revenues of 17.5%-18%, both relative to GDP. So far so good?
Okay then, today federal spending amounts to 23% of GDP and federal revenue, 15.5%. So spending is three percentage points above its long-run average and revenue is two percentage points below its long-run average. But if you add back revenue from the payroll tax holiday that both parties agree should expire at year-end, federal revenue is actually 16.2% of GDP. Sill below the historical average we should be shooting for, but don’t forget that the economy is still in the tank. Unemployment is nearly 8% and GDP growth is limping along at less than 2%. In a more robust economy, the Bush tax code could easily generate 18% of revenue. In fact, with today’s very same tax code, federal revenue was 17% of GDP in 2005, 18% in 2006, and 18.2% in 2007. The structure of tax rates is not the problem. The problem is economic growth—or lack thereof to be more specific. Even the Congressional Budget Office (CBO) recognizes that the Bush-tax rates would generate plenty of revenue if the economy was stronger.
The CBO forecasts that if the Bush tax rates were made permanent and economic growth picked up, federal revenue would rise to 17.2% of GDP in 2014, 17.8% in 2015, and 18.1% in 2016.
So why are the President and his allies in Congress so resolute on tax hikes? Beyond extracting a pound of flesh from the “rich” to satisfy their base, they want to expand the size and scope of government. Look no further than the President’s own budget (chart below). If the President had his druthers, by 2022 federal revenue would rise to more than 20% of GDP, and federal spending would rise to a permanently higher plateau of 23% of GDP.
As has been true through most of America’s modern political history, higher tax revenues are a ruse to expand the size and scope of government. Unfortunately, as best we can tell, a majority of Americans are still in the dark.