Taxation Can't Close Budge Gap

Jim Crumb
The law of diminishing returns effects taxation. Tax rates have natural limits, beyond which further levy becomes ineffective.

The 18 member Obama debt reduction commission chaired by Simpson and Bowles will be giving its final vote this Friday. Before then, there are two issues that must be understood.


First, the commission presents no ideas of how to grow the economy. Indeed spending is wildly out of control, but a growing economy might at least shrink the debt to GDP ratio.


Secondly, there is very little room to close the gap by increasing revenue through new or more aggressive taxation. Even a VAT tax is likely to prove unpopular as well as ineffective. A VAT would lower our spending power even further, likely leading to further reduction in tax collection. Revenue and spending reductions brought on by consumption taxes might chase each other into an abyss.


Historically, our tax to GDP ratio has hovered between 15-20 percent. We also know from past experience that the government can't raise taxes above 19% of GDP for too long. The bottom line is that while there is some opportunity to raise revenue, these efforts will be only marginally impactful, and will fall far short of closing the fiscal gap.


Spending must be cut. There is no other way.


Veronique de Rugy of George Mason University's Mercatus Center has a graph that reinforces this point nicely.




The law of diminishing returns effects taxation. Tax rates have natural limits, beyond which further levy becomes ineffective.

The 18 member Obama debt reduction commission chaired by Simpson and Bowles will be giving its final vote this Friday. Before then, there are two issues that must be understood.


First, the commission presents no ideas of how to grow the economy. Indeed spending is wildly out of control, but a growing economy might at least shrink the debt to GDP ratio.


Secondly, there is very little room to close the gap by increasing revenue through new or more aggressive taxation. Even a VAT tax is likely to prove unpopular as well as ineffective. A VAT would lower our spending power even further, likely leading to further reduction in tax collection. Revenue and spending reductions brought on by consumption taxes might chase each other into an abyss.


Historically, our tax to GDP ratio has hovered between 15-20 percent. We also know from past experience that the government can't raise taxes above 19% of GDP for too long. The bottom line is that while there is some opportunity to raise revenue, these efforts will be only marginally impactful, and will fall far short of closing the fiscal gap.


Spending must be cut. There is no other way.


Veronique de Rugy of George Mason University's Mercatus Center has a graph that reinforces this point nicely.