Eight Problems with a 'Balanced' (Tax-Raising) Approach

Everyone this side of Paul Krugman agrees we have a government debt problem.  A reasonable man might ask whether we solve it by cutting spending, raising revenue, or some mix of both.  The supposed "balanced" approach is, of course, some mix of both.  When the two parties can't agree, we good democrats (small "d") say split the difference.

The Simpson-Bowles deficit commission did exactly that.  That commission focused on the years 2015 and up, in which revenues were projected to be 19% of Gross Domestic Product and spending was projected to be 23% of GDP.  So the commission played Solomon and simply said both should be 21% of GDP.  The happy medium (and median, in this case) would then be struck and we would live happily ever after.

There are a few things wrong with that picture.

Problem 1.  It's not 2015 yet.  The Simpson-Bowles' 2015 was pure projection, a collection of assumptions thrown into somebody's computer.  In the real years that Barack Obama has been president, 2009-11, spending has been over the Simpson-Bowles assumption and revenues have been under -- by a lot.  Over Obama's first three years in office, spending will have averaged 24.7% of GDP and revenues 14.7%.

We have a 10% of GDP spending-revenue gap, not a 4% one as Simpson-Bowles assumed.  In 2011 dollars that means a $1.5-trillion gap every year, not a $600-billion one.  A Simpson-Bowles "haircut" turned into a scalping.

While all the projections assume some sort of back-to-normal economy, there has been no evidence of such movement in three years.  Recent data indicate just the opposite: a return to recession in a year or two, if we're not already in one.

Problem 2.  The projected revenues for 2015 already included the elimination of the Bush tax rates.  By recommending even more revenue, Simpson-Bowles recommended tax increases on top of tax increases.

Problem 3.  Simpson-Bowles recommended a revenue level of 21% of GDP.  The federal government has never in its history raised that much revenue.  Not ever.  Not even at the height of World War II or the peak of the Clinton-era boom.  The 1960-2000 average was 18.2% of GDP.  Even under Clinton's tax rates, tech-boom, and peace dividend years, 1994-2000, the average was 19.2% of GDP.

Problem 4.  Simpson-Bowles recommended a spending level of 21% of GDP.  That is more than was spent in any year in which George W. Bush was president.  It is also more than was spent in any year since 1994 and before Obama.  It is more than the 1960-2000 average (20.3% of GDP).

How can you criticize Bush for spending too much, at the same time you recommend spending even more?  You get rid of "Bush's" wars, as Simpson-Bowles assumes, and you still need to spend more than Bush ever did?  And you call that "balanced" and a "compromise"?

There's nothing balanced about the Simpson-Bowles plan.  It is a high-taxing, high-spending plan.  It simply "balances" revenue and spending at unprecedentedly high levels.  (At least unprecedented prior to Obama.)

Problem 5.  There is no guarantee that raising revenue will fix anything.  Yes, simple arithmetic says it is possible to eliminate the deficit by raising revenues.  But that assumes spending does not also go up.

From 1950 through 2008, federal revenues grew slightly: about 0.18% of Gross Domestic Product per decade.  However, spending grew almost three times as fast: 0.53% of GDP per decade.  For every $1 of new revenue, we spent $2.86.  You don't eliminate deficits that way.

All government spending in the U.S. today amounts to 41% of GDP.  Eleven "advanced economies" raised that much or more in revenue.  Do those countries have deficit or debt problems?  Yes.

Ten of those 11 countries have deficits in 2011.  Four of them have a net debt even bigger than ours: Belgium, France, Greece, and Italy.  Go ahead and congratulate Greece on being able to raise more revenue than the U.S. spends (as fractions of GDP); its debt is more than double ours as a percent.

Problem 6.  There is no guarantee that we even can raise enough revenue to eliminate Obama-sized deficits, especially by targeting the "rich."  You can raise tax rates all you want.  That does not mean you can raise revenue all you want.

As noted above, even under the benign assumptions of Simpson-Bowles, revenues would need to be 21% of GDP.  And we have never in our history been able to do that.  Not with a 35% top individual tax rate, a 39.6% top rate, a 70% top rate, or a 91% top rate.  Not ever.

When it comes to corporate taxes, we already have the highest rate in the world.  Do you think raising it even higher will bring in more revenue, or drive more business overseas?

The question of taxing the "rich" is not how much we like or dislike them, whoever they are.  It's whether we can get more money from them even if we are ruthless about it.  Straightforward analysis says it's not even possible; the rich don't have enough money.  What's worse, the rich are getting poorer.

Problem 7.  We just might be able to raise more revenue, but you're not going to like how.

Countries do exist with both high tax rates and low debts.  In 2011, three advanced economies had no net government debt at all; they had surpluses: Norway, Sweden, and Finland.  Norway collected 57% of GDP in revenue, Finland 53%, and Sweden 51%.  (The U.S. collects 41% of GDP.)

So it can be done.  And how does Sweden, for example, do it?

In 2010, the average local income tax rate was 31.56 percent. In addition to local income tax, the employee pays a state income tax of 20 percent on annual income exceeding SEK 383,000 [$59,000]. For incomes above SEK 548,300 [$84,000] the employee pays a state income tax of 25 percent.

And those are just income taxes.  The general VAT in Sweden is 25%.  The result is that everyone pays high taxes in Sweden.  Even the lowest-paid folks are handing over something like 50% of income and up.

As a matter of fact, Sweden's overall tax system is virtually flat: all income groups pay about the same rate.  For example, the top 10% in Sweden make 26.6% of the money and pay 26.7% of the taxes, for a ratio of 1.00.  In the U.S., the top 10% make 33.5% of the money, but pay 45.1% of the taxes, for a ratio of 1.35.

By this measure, the U.S. tax system is the most progressive of 24 OECD countries.  On the other hand, Sweden and Norway have two of the flattest tax systems, with ratios of 1.00 and 0.95, respectively.

Almost half the households in the U.S. pay no federal income tax at all, or even receive a credit.  Including all federal taxes (not just personal income taxes), the poorest quintile in the U.S. paid less than 5% of its income in taxes, but the highest quintile paid about 25%.  In Sweden by contrast, even the lowest-paid workers pay 50% or more of their income in taxes.

In short, to raise something like 45% to 50% of GDP in revenue, the U.S. would have to move to a Sweden-like flat, but high, tax system.  To get there, we would have to raise taxes on the poorest the most!

And even that is not a guarantee.  Many OECD countries have VATs and virtually flat taxes, yet also have high deficits and debts.  Not everyone is Sweden or Norway.  With the exception of Scandinavia, most of Europe has deficit and debt problems as bad as or worse than ours.  For all we know, if we try to imitate Sweden or Norway, we'll become Italy or Greece, instead.

Then again, there is Hong Kong.  Its net debt is zero.  It collects just 26% of GDP in revenue.  And it is running a surplus, not a deficit, in 2011.

Problem 8.  The bigger the share of the economy that goes to government, the slower the economic growth.  Are you ready for that trade-off?

Several studies have looked at the relationship between government size and GDP growth.  To my knowledge, all such studies concluded that smaller government (down to about 15% of GDP, anyway) is better for growth.  Two such studies, one done in 1998 by the Joint Economic Committee of Congress and the other done in 2009 by the Institute for Market Economics, concluded about the same thing: the growth rate of GDP is maximized at an overall tax rate of no more than 25% of GDP.

A chart might help.  Below is data for 33 advanced economies.

 

When looking at this chart, know that government expenditures in the U.S. right now are 41% of GDP.  Over the last year real GDP has grown 1.6%, matching the annual average over the last decade.

Now you have some facts for a fact-based analysis.  Balance away.

Randall Hoven can be followed on Twitter.  His bio and previous writings can be found at randallhoven.com.

Everyone this side of Paul Krugman agrees we have a government debt problem.  A reasonable man might ask whether we solve it by cutting spending, raising revenue, or some mix of both.  The supposed "balanced" approach is, of course, some mix of both.  When the two parties can't agree, we good democrats (small "d") say split the difference.

The Simpson-Bowles deficit commission did exactly that.  That commission focused on the years 2015 and up, in which revenues were projected to be 19% of Gross Domestic Product and spending was projected to be 23% of GDP.  So the commission played Solomon and simply said both should be 21% of GDP.  The happy medium (and median, in this case) would then be struck and we would live happily ever after.

There are a few things wrong with that picture.

Problem 1.  It's not 2015 yet.  The Simpson-Bowles' 2015 was pure projection, a collection of assumptions thrown into somebody's computer.  In the real years that Barack Obama has been president, 2009-11, spending has been over the Simpson-Bowles assumption and revenues have been under -- by a lot.  Over Obama's first three years in office, spending will have averaged 24.7% of GDP and revenues 14.7%.

We have a 10% of GDP spending-revenue gap, not a 4% one as Simpson-Bowles assumed.  In 2011 dollars that means a $1.5-trillion gap every year, not a $600-billion one.  A Simpson-Bowles "haircut" turned into a scalping.

While all the projections assume some sort of back-to-normal economy, there has been no evidence of such movement in three years.  Recent data indicate just the opposite: a return to recession in a year or two, if we're not already in one.

Problem 2.  The projected revenues for 2015 already included the elimination of the Bush tax rates.  By recommending even more revenue, Simpson-Bowles recommended tax increases on top of tax increases.

Problem 3.  Simpson-Bowles recommended a revenue level of 21% of GDP.  The federal government has never in its history raised that much revenue.  Not ever.  Not even at the height of World War II or the peak of the Clinton-era boom.  The 1960-2000 average was 18.2% of GDP.  Even under Clinton's tax rates, tech-boom, and peace dividend years, 1994-2000, the average was 19.2% of GDP.

Problem 4.  Simpson-Bowles recommended a spending level of 21% of GDP.  That is more than was spent in any year in which George W. Bush was president.  It is also more than was spent in any year since 1994 and before Obama.  It is more than the 1960-2000 average (20.3% of GDP).

How can you criticize Bush for spending too much, at the same time you recommend spending even more?  You get rid of "Bush's" wars, as Simpson-Bowles assumes, and you still need to spend more than Bush ever did?  And you call that "balanced" and a "compromise"?

There's nothing balanced about the Simpson-Bowles plan.  It is a high-taxing, high-spending plan.  It simply "balances" revenue and spending at unprecedentedly high levels.  (At least unprecedented prior to Obama.)

Problem 5.  There is no guarantee that raising revenue will fix anything.  Yes, simple arithmetic says it is possible to eliminate the deficit by raising revenues.  But that assumes spending does not also go up.

From 1950 through 2008, federal revenues grew slightly: about 0.18% of Gross Domestic Product per decade.  However, spending grew almost three times as fast: 0.53% of GDP per decade.  For every $1 of new revenue, we spent $2.86.  You don't eliminate deficits that way.

All government spending in the U.S. today amounts to 41% of GDP.  Eleven "advanced economies" raised that much or more in revenue.  Do those countries have deficit or debt problems?  Yes.

Ten of those 11 countries have deficits in 2011.  Four of them have a net debt even bigger than ours: Belgium, France, Greece, and Italy.  Go ahead and congratulate Greece on being able to raise more revenue than the U.S. spends (as fractions of GDP); its debt is more than double ours as a percent.

Problem 6.  There is no guarantee that we even can raise enough revenue to eliminate Obama-sized deficits, especially by targeting the "rich."  You can raise tax rates all you want.  That does not mean you can raise revenue all you want.

As noted above, even under the benign assumptions of Simpson-Bowles, revenues would need to be 21% of GDP.  And we have never in our history been able to do that.  Not with a 35% top individual tax rate, a 39.6% top rate, a 70% top rate, or a 91% top rate.  Not ever.

When it comes to corporate taxes, we already have the highest rate in the world.  Do you think raising it even higher will bring in more revenue, or drive more business overseas?

The question of taxing the "rich" is not how much we like or dislike them, whoever they are.  It's whether we can get more money from them even if we are ruthless about it.  Straightforward analysis says it's not even possible; the rich don't have enough money.  What's worse, the rich are getting poorer.

Problem 7.  We just might be able to raise more revenue, but you're not going to like how.

Countries do exist with both high tax rates and low debts.  In 2011, three advanced economies had no net government debt at all; they had surpluses: Norway, Sweden, and Finland.  Norway collected 57% of GDP in revenue, Finland 53%, and Sweden 51%.  (The U.S. collects 41% of GDP.)

So it can be done.  And how does Sweden, for example, do it?

In 2010, the average local income tax rate was 31.56 percent. In addition to local income tax, the employee pays a state income tax of 20 percent on annual income exceeding SEK 383,000 [$59,000]. For incomes above SEK 548,300 [$84,000] the employee pays a state income tax of 25 percent.

And those are just income taxes.  The general VAT in Sweden is 25%.  The result is that everyone pays high taxes in Sweden.  Even the lowest-paid folks are handing over something like 50% of income and up.

As a matter of fact, Sweden's overall tax system is virtually flat: all income groups pay about the same rate.  For example, the top 10% in Sweden make 26.6% of the money and pay 26.7% of the taxes, for a ratio of 1.00.  In the U.S., the top 10% make 33.5% of the money, but pay 45.1% of the taxes, for a ratio of 1.35.

By this measure, the U.S. tax system is the most progressive of 24 OECD countries.  On the other hand, Sweden and Norway have two of the flattest tax systems, with ratios of 1.00 and 0.95, respectively.

Almost half the households in the U.S. pay no federal income tax at all, or even receive a credit.  Including all federal taxes (not just personal income taxes), the poorest quintile in the U.S. paid less than 5% of its income in taxes, but the highest quintile paid about 25%.  In Sweden by contrast, even the lowest-paid workers pay 50% or more of their income in taxes.

In short, to raise something like 45% to 50% of GDP in revenue, the U.S. would have to move to a Sweden-like flat, but high, tax system.  To get there, we would have to raise taxes on the poorest the most!

And even that is not a guarantee.  Many OECD countries have VATs and virtually flat taxes, yet also have high deficits and debts.  Not everyone is Sweden or Norway.  With the exception of Scandinavia, most of Europe has deficit and debt problems as bad as or worse than ours.  For all we know, if we try to imitate Sweden or Norway, we'll become Italy or Greece, instead.

Then again, there is Hong Kong.  Its net debt is zero.  It collects just 26% of GDP in revenue.  And it is running a surplus, not a deficit, in 2011.

Problem 8.  The bigger the share of the economy that goes to government, the slower the economic growth.  Are you ready for that trade-off?

Several studies have looked at the relationship between government size and GDP growth.  To my knowledge, all such studies concluded that smaller government (down to about 15% of GDP, anyway) is better for growth.  Two such studies, one done in 1998 by the Joint Economic Committee of Congress and the other done in 2009 by the Institute for Market Economics, concluded about the same thing: the growth rate of GDP is maximized at an overall tax rate of no more than 25% of GDP.

A chart might help.  Below is data for 33 advanced economies.

 

When looking at this chart, know that government expenditures in the U.S. right now are 41% of GDP.  Over the last year real GDP has grown 1.6%, matching the annual average over the last decade.

Now you have some facts for a fact-based analysis.  Balance away.

Randall Hoven can be followed on Twitter.  His bio and previous writings can be found at randallhoven.com.

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