You Got Your Tax Increase, Dems...Now Show Us the Money

The so-called fiscal cliff has been avoided, at least for the time being, and all it cost was a tax rate increase on the nation's most productive taxpayers.  Of course, conservatives are disappointed, but one also needs to appreciate that with all the Bush tax rate decreases set to expire automatically, Democrats had Republicans over a barrel.  That being the case, Republicans didn't do so badly, considering.  The higher rates that would have kicked in at incomes above $250,000 (for marrieds, $200,000 for singles) will instead apply only to incomes above $450,000 (for marrieds, $400,000 for singles).  And the formerly temporary Bush rates on incomes of $450,000 and below have now been made permanent.

The bad news is that at least some Democrats, such as New York Senator Chuck Schumer, see the recent rate increases as just a first step, a prelude to demanding "additional revenue" as part of any agreement to deal with the debt ceiling.

Well, good luck with that, Chuck, or did you not notice that when your ability to hold taxpayers hostage to automatic tax rate increases disappeared, any leverage you might have had disappeared with it?  But that doesn't mean that Republicans can sit idly, as the Democrats did with the fiscal cliff, and wait passively for events to produce a favorable result.  Because as sure as night follows day, and Chuck Schumer follows a TV camera, Democrats will continue to argue for the "additional revenue" they believe to be absolutely necessary to reduce the budget.

And Democrats will continue to believe that their tax rate increases will actually produce the revenue they predict it will.

They will not, and this is how I know.  The Federal Reserve Bank of St. Louis recently published a report, "The U.S. Deficit/Debt Problem:  A Longer-Run Perspective," providing both a diagnosis and prognosis of the nation's deficit/debt problem.  First, the diagnosis -- and, along with it, a thorough debunking of a myth Republicans have allowed Democrats to get away with for far too long: that our current deficits and soaring debt began in 2008 and were caused by the subprime and banking crises in the latter years of the century's first decade (emphases mine).

Given the emphasis on the financial crisis and its aftermath, it is important to realize the U.S. deficit/debt problem began over four decades ago.  This longer-run perspective suggests that the recognition of the seriousness of the problem and the need for fundamental change eventually would have occurred.  The recent financial crisis merely brought the U.S. deficit/debt problem to the public's attention sooner rather than later.  The... U.S. deficit/debt problem began during the early 1970s when the government started to increase spending significantly without a corresponding increase in tax revenue.

The top marginal rate in the early 1970s, by the way, was 71.5 percent on taxable income above $200,000 -- and the federal government still spent significantly more than it took in.  You liberals who are anticipating utopian results from a top rate almost 45 percent less than that might want to take note.

Note also (I must be fair here) that the hyperbolic arc in federal spending began under a Republican president, Richard Nixon, and then continued to rise through the administrations of every president, Republican and Democrat.  Why, over the long haul, Republicans apparently have had no more luck in balancing budgets than have Democrats becomes clear if one studies the below chart from the St. Louis Fed  report:

As the report demonstrates (emphases mine):

IPD [(Interest Paid on the Public Debt)] and OFE [(Other Federal Expenditures)] have been relatively small and relatively constant over the period, with no discernible trend.  Hence, the marked increase in spending cannot be due to IPD or OFE.  It also appears that DS [(Defense Spending]) cannot account for the spending increase as it has generally trended down over the sample period ever since the late 1960s.

The figure shows that SSM [(Social Security and Medicare/Medicaid)] and OPI [(Other Payments to Individuals)] are the main spending drivers over the 1970-2007 period.  These expenditures accounted for 5 percent of government spending as a percent of GDP in 1950 and had increased to only 6.1 percent of GDP by 1969.  However, SSM and OPI spending as a percent of GDP doubled by 2007 to 12.1 percent of GDP.  SSM and OPI spending increased by another 3.6 percentage points of GDP by 2010 to 15.7 percent of GDP.

Meanwhile, and in fairness to presidents and lawmakers from both parties (emphasis mine):

Discretionary spending decreased from 48 percent to 37 percent of total government spending between 1979 and 2011, while mandatory spending increased from 44 percent to 56 percent of total spending.

And once we know, contrary to conventional wisdom, that the percentage of discretionary spending -- the non-automatic spending over which Congress and the president exercise complete control -- has decreased over the past four decades, it should surprise no one that (emphasis mine) "OPI and SSM account for essentially all of the increase in government spending that has given rise to the deficit/debt problem."

One can argue whether the nominal growth in and absolute amount of discretionary spending are excessive; perhaps, someday, I will.  But today I raise the matter not to defend either party from the charge of excessive spending, but only to demonstrate the potential ineffectiveness, if not sheer folly, of attempting to balance the budget by reducing discretionary spending.  Been there, done that.

And that folly pales in foolishness beside that of trying to balance a budget with tax rate increases, and it is in debunking this bedrock liberal belief that the St. Louis Fed's report is most devastating:

Examining the above chart, we see that (emphases mine):

... the numerous changes in marginal individual income tax rates have had little perceptible effect on tax revenue, either as a percent of GDP or individual income tax revenue as a percent of total tax revenue.  The marginal tax rate over this period ranged from a high of 70 percent and a low of 30 percent with no marked change in individual income tax revenue as a percent of GDP.

The study posits two primary reasons why this would be the case:

• When marginal tax rates increase, individuals have a stronger incentive to manipulate their total tax by exploiting the loopholes.
• Higher marginal tax rates also provide a stronger incentive for production to go "under- ground." This is particularly true for the service sector and smaller businesses where it is much easier for transactions to be facilitated with cash so that some income can effectively be sheltered from taxes.

And to these two reasons why the relationship between tax rates and revenues actually collected ranges from ephemeral to nonexistent, permit me to add a third: when people believe, in their gut, that they are being taxed at an unfair rate, they will do whatever they can to "stick it to the man" and not pay the taxes.

But whatever the reason or reasons, the main point the report makes is that "there is only a weak relationship between marginal tax rates and tax revenue."

In plain English, the odds are slim to none that $650 billion Democrats expect to realize from their tax increase will actually manifest.  Indeed, the federal government could even lose money, as happened when Britain recently raised her top rate (emphasis mine):

Our calculation shows that the combination of higher VAT, higher National Insurance Contributions and increased labour and capital mobility mean that the 50% rate of Income Tax is likely to lead to a loss of tax revenue for the Government.

So either the Democrats have not been paying attention or "it's different this time," or else there's some combination of the two.  I don't know; I'm not a liberal.  But we conservatives are generous folks, so let's give the benefit of the doubt to our friends across the aisle, who think they can erase a $16-trillion deficit with nothing more than a left-wing and a nonsectarian prayer and assume, in arguendo, that the new 39.5-percent top rate does what Britain's 50 percent rate could not and actually produces the predicted revenue -- every penny of it.  Even then, unless this time it truly is different, history and the St. Louis Fed's analysis point to a prognosis that is, how you say, not so good.  That's because (emphasis mine):

... there is a deeper and more fundamental issue that must be addressed if the problem is to be resolved solely or primarily by raising taxes. ... [T]he deficit/debt problem began when the government decided to increase spending significantly without increasing taxes.  If the problem is resolved by increasing taxes to a higher percentage of GDP to match current expenditures, there would be no guarantee that the government would not simply increase spending further, thereby starting down a path to the next deficit/debt problem.  The long-run perspective suggests there can be no permanent solution to the deficit/debt problem until a mechanism can be established that prevents the government from running persistent deficits.

Nor, I would add, can there be a permanent solution unless and until we reform Social Security, Medicare, and other transfer programs -- but especially Medicare, the biggest driver, by far, of the deficit/debt.  It is absolutely essential to take the mandatory spending on these programs off autopilot.  And, of course, we must repeal ObamaCare, which, at its core, constitutes a massive expansion of Medicare, not to mention the massive increases in health care costs and health care premiums that we are already seeing and that can only make an already horrendous problem even worse.

Obama and the Democrats, of course, will never acknowledge the fundamental, inherent flaws in all -- all -- of their entitlement programs.  A pickup truck-driving Alabama redneck clinging to his guns and religion has nothing on the tenacity with which an Upper-West-Side liberal will cling to his belief that every problem can be solved, every budget balanced, by raising tax rates on a tiny sliver of the population.  It would thus behoove House and Senate Republicans, if they can suspend being the Stupid Party long enough to do it, to keep track of the actual revenues raised -- or not raised -- by the Democrats' latest rate increase and publicize the results, which I fully expect to come up short.  But I won't hold my breath.

What I will do is say that when it comes to tax revenues, this native Michigander is from Missouri.  You're gonna have to show me.

You got your tax rate increase, Democrats.  Now show us the money.

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