Let's Compromise on Taxes

The Bush tax rates are about to expire. Republicans want to extend the Bush rates. Democrats want them to go back up to pre-Bush levels. I say we compromise: let the rates go back up for everyone who makes less than, say, $200,000 per year.

First, I would prefer that we extend all the Bush rates. Those rates were in place in 2006 and 2007, for example. Yet, somehow, the federal government was able to collect a higher fraction of the economy in those years than it averaged for the four decades prior to George W. Bush's presidency. And the deficits in those years were only 1.9% and 1.2% of GDP, respectively -- lower than the average of those same four decades -- and, of course, much lower than the 10% under President Obama and the Democrats so far. (Source: Office of Management and Budget, Table 1.2.)

But a poor-girl federal government can't be expected to survive on just one fifth of the economy anymore.

From 1960 through 2008, federal revenues averaged 18.1% of GDP, and spending averaged 20.2%, leaving an irritating average deficit of 2.1% of GDP. Remember those numbers. (In 2007, the last fiscal year under a budget written by a Republican-controlled Congress, the respective numbers were 18.5%, 19.6%, and 1.2% -- all better than average.)

Now, if future revenues were expected to fall below that 18.1% of GDP average, one might justifiably say we need to boost revenues. But OMB expects them to be 18.9% of GDP -- higher than average -- in 2015, the Deficit Commission's target year. That is not a shortfall of revenue at all, if you consider historical levels as your benchmark. In fact, in no ten-year interval in U.S. history has the federal government averaged over 18.8% of GDP in revenue. Ever. In history.

Get it? The federal government is expected to collect more money than it ever has in its history, and we are being told we have a revenue shortfall problem.

What we have is a spending problem. Federal spending went from 19.6% of GDP in 2007 to 25.4% in 2010. That is a spike of about $850 billion in today's dollars. (Coincidently, I'm sure, Obama's stimulus was $814 billion.)

Blame some of that on recession spending, stimuli, etc. But by 2015, years after the recession is deemed over and growth is assumed to be healthy, OMB expects spending to be 22.9% of GDP. Since World War II, there has been no ten-year interval in which federal spending averaged more than 22.2% of GDP.

So tax revenues are expected to be 0.8% of GDP above historical levels, but spending is expected to be 2.7% above historical levels. See the problem? If you are a Democrat, the problem is that we are not raising revenues even more above levels unprecedented in both peacetime and wartime.

But being a good citizen, I seek compromise as much as the next guy. So let's not raise taxes on everybody. That wouldn't be compromise. That wouldn't be bipartisan. That wouldn't be adult. It would make Alan Simpson cuss or something.  So...let's just raise them on those making less than $200,000 per year.

There are two good arguments for doing this: fairness and effectiveness.

Fairness. Look at this chart just recently produced by the Congressional Budget Office. The top 20% of taxpayers are the only ones who pay a greater percentage of taxes than their percentage of total income. And this is not just income tax, but all federal taxes: payroll (Social Security and Medicare), corporate, excise, etc. The richest 20% (average income of $264,700 in 2007) pay more than their fair share, and the rest of us pay less. (Full disclosure: my household's income was less than $264,700 in any year you can name.)

Now, maybe you are thinking the rich should pay more taxes even as a percentage of what they make; it was Bush's tax rate cuts that skewed the tax code even more toward the rich. Suit yourself. But look at the facts, according to the CBO.

Again, these are all federal taxes, not just income taxes. Look at any quintile on this chart and compare the number in 2007 to the one in, say, 1985. That top quintile, America's wealthiest, paid about 25% of their incomes in taxes in 2007, just about like they did a quarter of a century before. But look at those lower quintiles. The lowest went from about 10% to 5% -- a cut of 50% in taxes for them. All the quintiles, other than the top one, were paying less in taxes than they were 25 years ago.

Think I'm lying? Here is what the CBO said.

The lowest three income quintiles have seen declines in their average tax rates since the early 1980s ... The extent of the decrease was the greatest for the lowest quintile, for which the [income tax] rate dropped by nearly 7 percentage points between 1979 and 2007... about 35 percent of households did not owe any federal income taxes ...

So not only do the wealthiest Americans pay a disproportionate share of federal taxes, but their share compared to the non-wealthiest has increased since Reagan cut tax rates in the 1980s and again since Bush cut tax rates in the 2000s.

It is only fair to raise tax rates on the non-wealthy.

Effectiveness.  Let's say you don't care at all about fairness; you just want to raise revenue in the most effective manner because you are so darned concerned about that deficit.  Will you get the most by raising tax rates on the rich?

If the highest tax bracket in 2008 had been 39.6% (the pre-Bush level) instead of 35% (post-2003 level), and if the affected households had not changed one iota of behavior because of that, the federal government would have raised an extra $28.6 billion. That would have covered less than four days' worth of federal spending and left a deficit of $430 billion instead of $459 billion.

Even if you get all of it, it is not that much. But you wouldn't get all of it. One study says that increasing nominal taxes $1 on labor would collect only 68 cents, and increasing them on capital (where the rich earn their money, supposedly) would collect just 49 cents. So that $28.6 billion you thought you'd get quickly evaporates to maybe half that: two days' worth of federal spending, perhaps. For all we really know, no new revenue would show up. The rich could just decide to live off accumulated wealth. That's what being rich means: never having to say "sorry, boss." The truly rich don't need income.

In 2008, the federal government collected $550 billion in income taxes on households with incomes less than $200,000. The total income of those households was about $3.6 trillion. So the average tax rate was a little over 15%. What if that was raised to just 16%? That extra 1% of taxes on the non-wealthy would raise about $36 billion - more than would be raised by raising the top marginal rate on the rich by 4.6 percentage points. (See IRS Table 3.5.)

Government gets the money from where the money is: the middle class -- you and me. Why do you think every European country has a VAT? A typical VAT is 20%. Buy a $25,000 car in Europe and expect to pay $5,000 for VAT. A VAT, being a consumer tax, is essentially regressive. European governments are able to collect pretty big fractions of their GDPs that way. (Funny how they still have huge deficits and debt, though.) The U.S. taxes corporations at the second-highest rate in the developed world. Europe just taxes every transaction by everybody. They seem to get more money that way.

You know another way to make taxes more regressive? Raise income tax rates on the non-wealthy. Paul Krugman isn't a total idiot; he knows that to raise significantly more money, the federal government needs something like a VAT. But until we get a real VAT, the next-best thing is an increase in income taxes on the non-wealthy.

Summary. Our wise leaders have determined that we simply cannot exist as a country if the federal government taxes and spends at rates similar to the rates of the last half-century. To be a modern country, like Greece, we must increase the size of our government to levels unseen in U.S. history. Or else we all die, or might get unemployment checks for only two years at a time.

To avoid such catastrophes, and in the interest of bipartisanship, I offer a compromise: extend the Bush tax rates only for the wealthiest Americans. It is the most fair and effective way, given that we cannot extend them for everyone. You're not against fairness and effectiveness, are you?

Randall Hoven can be contacted at randall.hoven@gmail.com or via his website, randallhoven.com.