Higher taxes can't solve the deficit

In the ongoing battle between the fiscal conservatives and the liberal Democrats, there appears little chance of any meaningful movement toward fiscal sanity without the so-called ultimate weapon of a shutdown being employed.   The conservative element of the Republicans in the House and Senate claim that only massive spending cuts can save the country from going off a financial cliff into bankruptcy.  The Democrats counter that spending really isn't the problem -- the country can afford the spending and more; it is that the rich are not paying enough in taxes.

That same argument is used in various state capitals as well where the states are facing their own financial armageddon in battles with the public sector unions.

The public, which has its own issues of joblessness and a rising cost of living, is caught in the middle.  It sounds very easy and somewhat fun to stick it to the rich rather than cut a program someone somewhere (which the media will find) cannot live without.  However they also instinctively know that it is the rich that create jobs and wealth.

Perhaps the answer lies in understanding the dimension of the current financial dilemma and whether taxing the rich really does solve the problem.

The latest Congressional Budget Office report concludes that the country will average an annual budget deficit close to $750 Billion per year for the next ten years including this year.   Therefore the national debt will rise by nearly $7.5 Trillion dollars to a total debt of over $21.5 Trillion (115% of the nation's projected gross national product) putting the nation into technical insolvency.

With that figure agreed upon, what would be the impact of raising the taxes rates on those filers with modified taxable income above $200,000.00 per year?   The most recent comprehensive data on income and tax filing was issued by the IRS in October 2010 and is for the 2008 taxable year.  (http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133521,00.html)

For this exercise, a few hard-to-believe assumption must be made: 1) that Congress would apply all additional revenue to the deficit and debt, 2) that no new programs would be initiated, 3) the spending assumptions for items such as ObamaCare, Medicare and Social Security are 100% accurate and 4) there would be no catastrophic natural or man-made disasters.

In 2008 there were 4,359,000 tax returns filed with modified taxable income (MTI) of $200,000 or above.  The total amount of MTI above $200,000 was $1.189 Trillion.  Using the simplest calculation possible, let us assume the current income tax rate of 35% was increased by a factor of 20%.  The new tax rate of 42% would generate an additional $237 Billion in revenue to the government per year.  If fully applied to the deficit per the CBO, then the deficit would be reduced to $513 Billion per year and the debt would increase by $5.1 Trillion over ten years to a total indebtedness of $18.8 Trillion still 100% of projected GDP.

If the current top income tax rate would be increased by 40% to a rate of 49%, then theoretically the additional income to the government would increase by $474 Billion per year and reduce the deficit to $276 Billion per year, and the overall debt would go up by $2.8 Trillion over ten years to a total indebtedness of $16.7 Trillion (88% of projected GDP)

The overall effective tax rate (incl. Medicare, average state income tax and misc income taxes) for those in the highest income category would be 51% (if the Federal rate were increased by 20%) and 57% (if increased by 40%).  This is before the impact of such items as property taxes, excise taxes etc.  The average person would acknowledge that when the overall tax impact on every dollar above $200,000 would be taxed at 55 to 65%+, then the incentive to earn more money would be greatly diminished.

This phenomenon has been documented by Arthur Laffer and his Laffer Curve which shows that the higher the tax rate the less tax revenue is collected by the government.

Even in an ideal world, discounting human nature, and with the Congress on their best fiscal behavior in the future, raising taxes on the so-called rich will not solve the country's financial problems.  Raising the rates too high will in fact make matters worse.  It is time to stop listening to the snake oil salesmen in the Democratic Party and their tired class warfare rhetoric and get serious about cutting spending.