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Taxes Won’t Eliminate Federal Deficits

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Taxes Won’t Eliminate Federal Deficits

August 29, 2017

For several decades, Washington Post columnist Robert Samuelson has been one of the most articulate defenders of entitlement and spending reform. He has repeatedly emphasized our collective responsibility to confront long-term budget deficits, avoid the temptation of half-baked easy solutions, and soberly work through trade-offs.

This makes his August 27 column, “We Need Higher Taxes,” so baffling. The problem is not that Samuelson supports tax increases – he has long favored a combination of new taxes and entitlement reforms – but rather that he presents new taxes as an economically-easy solution while barely acknowledging the need for spending restraint.

Samuelson states, “The truth is that we need higher, not lower, taxes. When the economy is at or near “full employment,” the budget should be balanced or even show a slight surplus… while the deficit for fiscal 2017 is reckoned to approach $700 billion…We are undertaxed. Government spending, led by the cost of retirees, regularly exceeds our tax intake.”

Nowhere in that statement is an acknowledgement that runaway spending is driving the budget deficits. Revenues – which have average 17.4 percent of  GDP over the past 50 years – are projected to average 18.2 percent over the next decade, and rise to 19.6 percent within 30 years. The individual income tax burden is gradually rising to its highest sustained level in American history.

On the other hand, federal spending, which has averaged 20.3 percent of GDP over the past 50 years, is set to average 22.4 percent over the next decade, on its way to 29.4 percent in 30 years. Mathematically, the entire long-term rise in budget deficits is projected to come from escalating spending exceeding a historic revenue surge.

Instead of addressing the spending driving the deficits, Samuelson takes federal spending as a given and implies that taxes should be raised to match it. Not until the final paragraph does he briefly mention “lower benefits” as one part of the solution.

The primary purpose of Samuelson’s column is to argue that America cannot afford a large tax cut as part of tax reform. With the national debt set to rise from $20 trillion to $30 trillion over the next decade, that is largely true. Even though Americans are entering an era in which they will be significantly overtaxed by the standards of the past 50 years, a large tax cut is simply not affordable – and would likely poison the well for necessary entitlement reforms.

Yet Samuelson advocates a tax-heavy solution to the deficit without offering any realistic blueprint to get there. The only policy he specifies is a phased-in carbon tax “as a pragmatic way to pay for the government we want.” But a carbon tax would barely make a dent in the long-term deficit. The Congressional Budget Office estimates that even an aggressive carbon tax – without a lengthy phase-in – would close less than 10 percent of the ten-year budget deficit (a share that would fall over time). The longer phase-in Samuelson advocates as well as the necessary rebates for low-income families hit hardest by a carbon tax would reduce this policy’s long-term deficit reduction to less than 5 percent.

The same goes for other tax hikes: Even doubling the top two income tax brackets to 70 percent and 80 percent would close just one-quarter of the annual Social Security and Medicare deficit in 2027, and one-eighth of the annual shortfalls by 2047. Other popular proposals to raise taxes on investors, oil and gas producers, banks, and hedge fund managers would collectively close less than 5 percent of the long-term Social Security and Medicare shortfalls. These entitlement programs are simply growing too fast for taxes to catch up.

Finally, Samuelson asserts that there is no significant link between low tax rates and economic growth. His only evidence is a 2014 Congressional Research Service report by Thomas Hungerford that had to be retracted for its methodological shortcomings. In reality, a large and growing body of academic literature shows that low tax rates encourage economic growth. Nobel Laureate Ed Prescott has shown that lower tax rates explain much of the reason America has grown faster than Europe. Even liberal economists such as former Obama White House Council of Economic Advisers Chair Christina Romer has  calculated  that tax increases significantly harm economic growth.  For a real-world example, look no further than the 25-year economic boom after President Reagan began cutting taxes across the board, including bringing the top income tax bracket down from 70 percent to the 28 percent to 40 percent range.

The last notable tax rate reductions occurred in 2003. These tax rate cuts were much more pro-growth than the 2001 tax cuts, which were phased in slowly and based more on Keynesian tax rebates. The chart below shows how economic growth, business investment, jobs, and the stock market all responded immediately to the May 2003 tax cuts. No serious economist has argued that tax policy had any role in the housing collapse that ended this economic boom in 2008.

Asserting that tax rates do not matter much to economic growth contradicts all economic theory – from classical to Keynesian to supply-side to monetarist. It implies that incentives do not matter, prices do not matter, and that all economic booms following tax rate reductions were just a coincidence. It is essentially to negate the entire field of economics.

At the end of his column, Samuelson calls for “a more honest debate” on taxes and spending. That should include a debate about the role of incentives and federal spending.

Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on twitter @Brian_Riedl.

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