The coming tax bomb

[SHTSPRAYER]

The Coming Tax Bomb
By JOHN F. COGAN and R. GLENN HUBBARD
April 8, 2008; Page A21

As the presidential campaign enters its final stages, there will be increased debate over budget priorities and how they will be paid for. Many commentators and political leaders, including Sens. Hillary Clinton and Barack Obama, believe that tax increases are needed to restore near-term budget balance and finance longer-term entitlement growth.

These claims fail budget arithmetic and economics. Worse, they raise serious questions about the nation's broad fiscal policies and its commitment to economic growth.

By historical standards, federal revenues relative to GDP, at 18.8% last year, are high. In the past 25 years, this level was only exceeded during the five years from 1996 to 2000. Still, we stand on the verge of a very large tax increase, one that will occur unless the next Congress and president agree to rescind it. Letting the Bush tax cuts expire will drive the personal income tax burden up by 25% – to its highest point relative to GDP in history.


This would be the largest increase in personal income taxes since World War II. It would be more than twice as large as President Lyndon Johnson's surcharge to finance the war in Vietnam and the war on poverty. It would be more than twice the combined personal income tax increases under Presidents George H. W. Bush and Bill Clinton. The increase would push total federal government revenues relative to GDP to 20%.

Why this large tax increase? The tax code changes enacted in 2001 and 2003 are scheduled to expire at the end of 2010. If they do, statutory marginal tax rates will rise across the board; ranging from a 13% increase for the highest income households to a 50% increase in tax rates faced by lower-income households. The marriage penalty will be reimposed and the child credit cut by $500 per child. The long-term capital gains tax rate will rise by one-third (to 20% from 15%) and the top tax rate on dividends will nearly triple (to 39.6% from 15%). The estate tax will roar back from extinction at the same time, with a top rate of 55% and an exempt amount of only $600,000. Finally, the Alternative Minimum Tax will reach far deeper into the middle class, ensnaring 25 million tax filers in its web.

Proponents of bigger government invariably argue that allowing all or some of President Bush's tax cuts to expire is necessary in the near term to balance the federal budget, and necessary in the longer term to finance the retirement and health-care promises made to the baby-boom generation. But a tax increase is neither wise nor necessary.

As has so often been true in the past, the economic damage caused by the tax increases and tax avoidance behavior will prevent the promised revenues from being realized. At the same time, the promise of higher revenues will encourage Congress to continue its profligate spending. As a result, a tax increase won't lower the budget deficit.

Moreover, current tax rates can be maintained and even reduced and still allow for necessary increases in national security appropriations and the balancing of the federal budget. Although budget balance may not be achieved overnight, a firm commitment by the next president to spending control will enable balance by the end of his or her first term.

Balancing the federal budget without a tax increase will require strong fiscal restraint. To achieve balance by the end of the next president's term in office, federal nondefense spending growth needs to be restrained to 2% per year instead of the currently projected 4.5%. This will be tough, but the federal government has been on a bipartisan spending binge for a decade. How large is this binge? Compared to the 1997 level adjusted for inflation and new homeland security spending, in 2007 actual nondefense appropriations were $125 billion higher, or cumulatively, a nearly $900 billion excess for the decade. If the next two congresses were to remove this excess gradually and shave 1% per year from projected entitlement growth, the budget could be balanced.

But what about national security? Certainly, balancing the budget without raising taxes requires that the wars in Iraq and Afghanistan be brought to a successful conclusion over the next five years. However, it does not require that the U.S. troop presence in either country be eliminated. Nor does balancing the budget preclude overdue and necessary increases in the defense budget.

The costs of needed improvements in our national security, though seemingly large, are small when measured in the context of the federal budget. According to the Congressional Budget Office, adding 100,000 active duty soldiers and 60,000 Army or National Guard members costs about $25 billion per year. Increasing the size of the Defense Department's procurement budget by 25% costs a similar amount. Each of these adds just 0.1% to annual federal spending – a small difference in the federal budget, but a powerful addition to our nation's security.

The current economic slowdown will increase the federal budget deficit this year and, in all likelihood, next year as well. But as the economy enters its recovery phase, raising taxes would choke off the recovery. The right policy, for both the economy and the budget, would be to make current tax rates permanent well before the scheduled increase. Giving investors greater certainty that current tax rates will be maintained will spur investment and aid the economic recovery, as it did in 2003. Federal budget balance will be achieved once the economy is again operating on all its cylinders.

This near-term budget debate foreshadows the more significant long-term budget debate the next president must lead. The CBO tells us that after a generation, Social Security and Medicare spending, left unchecked, will rise by 10 percentage points of GDP. Continuing the current hands-off entitlement policy will have severe consequences. The strategy of ratifying spending with higher taxes would require that all federal taxes rise by nearly 60%, bringing them to a European-level tax burden.

We still have time to prepare for the looming entitlement problem. Although baby boomers soon begin their retirement, the real impact of their numbers on the federal budget will not be felt for a decade. According to official budget forecasts, Social-Security costs will claim 4.5% of GDP in 2013, no higher than its claim on GDP during the first half of the 1990s.

Having time is no excuse for inaction, but a near-term tax increase is the wrong way to prepare. Higher revenues will encourage Congress to raise spending, compounding the long-term budget problem. And, the long-term tax increase required to fund unchecked long-term spending would likely reduce annual GDP growth by a full percentage point.

The proper way to prepare to meet the entitlement challenge consists of three essential elements: Change entitlements to slow their cost growth; eliminate all nonessential spending in the remainder of the budget; and, most important but often overlooked, adopt policies that promote economic growth. The greater the economic growth, the larger the economic pie, and the greater the public and private resources available to finance entitlement obligations and other national priorities.

Last year's federal budget illustrates the importance of economic growth to the federal budget's overall health. The federal budget deficit was recorded as 1.2% of GDP, half its average level over the past four decades. This modest deficit occurred despite the fact that Congress has been on a decade-long spending binge; despite the fact that not a single entitlement program has been significantly reduced since the late 1990s and two entitlements, Medicare and farm support payments, have been significantly increased; and despite the fact that we are in the midst of costly but necessary wars in Iraq and Afghanistan.

The consensus that tax increases are needed for fiscal balance is wrong. The next president can fund our defense priorities, maintain tax cuts, and balance the budget. A tax-increase consensus blurs the basic debates over our budget priorities in 2008 – and severely limits our choices in 2028.

Mr. Cogan, a senior fellow at the Hoover Institution, was deputy director of the Office of Management and Budget under President Reagan. Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush.

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[SBK]

But rich people are screwing the working man and need to bend over and pay their "fair share!!!" And by rich people I mean anyone who makes either more than me or more than I deem necessary!

[little jacob]

"tax increases are needed to ...finance longer-term entitlement growth. "

that was as far as I got before having a maalox moment

[banyon]

I love how this article doesn't feel it necessary to mention that most of the so-called "tax increase" is actually just a rollback of Bush's cuts on people making over $250k a year.

[Guru]

Originally Posted by banyon

I love how this article doesn't feel it necessary to mention that most of the so-called "tax increase" is actually just a rollback of Bush's cuts on people making over $250k a year.

I don't make anywhere near $100k a year. If the Bush tax cuts goes away in 2010, my taxes will jump by nearly $2000. Obama's paltry $1000 cut to middle class means absolutely SHIT to me after that change.

[Guru]

Originally Posted by little jacob

"tax increases are needed to ...finance longer-term entitlement growth. "

that was as far as I got before having a maalox moment

[2bikemike]

Originally Posted by Guru

I don't make anywhere near $100k a year. If the Bush tax cuts goes away in 2010, my taxes will jump by nearly $2000. Obama's paltry $1000 cut to middle class means absolutely SHIT to me after that change.

I know I will get taxed more under the Obama plan. And if he gets his way and raises the cap on Social Security it will be a double hit. Not to mention Capital Gains. I am sick and tired of the BS in Washington. Fire the lot of them bastards and lets start over. I live within my budget its about time those bastards learn to live within theirs.

[ROYC75]

Originally Posted by Guru

I don't make anywhere near $100k a year. If the Bush tax cuts goes away in 2010, my taxes will jump by nearly $2000. Obama's paltry $1000 cut to middle class means absolutely SHIT to me after that change.

It would be close to a $ 4000.00 tax increase to me and I struggle to make ends meet now.

That's what I call a " Change " ...........

[Guru]

Originally Posted by 2bikemike

I know I will get taxed more under the Obama plan. And if he gets his way and raises the cap on Social Security it will be a double hit. Not to mention Capital Gains. I am sick and tired of the BS in Washington. Fire the lot of them bastards and lets start over. I live within my budget its about time those bastards learn to live within theirs.

Holy cow!!!! Logic in the DC forums.

America is dumb though. We keep putting the same idiots back in their chair. TERM LIMITS NOW!!! I am sick of people winning on name recognition.

[Guru]

Originally Posted by ROYC75

It would be close to a $ 4000.00 tax increase to me and I struggle to make ends meet now.

That's what I call a " Change " ...........

also, that $1000 tax cut of BO only applies to Americans earning $75k or less. That might have been the line for middle class 25 years ago but it is nowhere near it now.

[tiptap]

You all will have to explain to me how you let the Republican sink our country deeper in debt over 7 years and why the Democrats decision to set the financial house in order isn't the responsible thing to do. The Republicans got just what they set out to do. To saddle the government with debt so that Democrats are hamstrung in advancing their agenda. They got to spend money on the Military (see Banyon's Eisenhower quote) industrial complex and the lion share going to private armies at that.

Compared to the stewardship of the Bush bubble economy, the Clinton higher tax approach provided a more sustainable push. The small correction at the beginning of Bush term is nothing like this black hole. It is worst than the one Reagan handed over to Clinton.

[patteeu]

Originally Posted by tiptap

You all will have to explain to me how you let the Republican sink our country deeper in debt over 7 years and why the Democrats decision to set the financial house in order isn't the responsible thing to do. The Republicans got just what they set out to do. To saddle the government with debt so that Democrats are hamstrung in advancing their agenda. They got to spend money on the Military (see Banyon's Eisenhower quote) industrial complex and the lion share going to private armies at that.

Compared to the stewardship of the Bush bubble economy, the Clinton higher tax approach provided a more sustainable push. The small correction at the beginning of Bush term is nothing like this black hole. It is worst than the one Reagan handed over to Clinton.

If the democrats had really decided to "set the financial house in order" there would be nothing wrong with it. But that's not what they've done. Instead, they've decided to expand the size and scope of government dramatically while giving lip service to paying for it by attacking the rich with punitive taxes. If anyone ever really decides to set the financial house in order, one of the main components of that effort will be spending restraint. You must have forgotten that the Clinton era was benefited greatly by a significant degree of spending restraint on the part of Congress.

[penguinz]

Originally Posted by Guru

also, that $1000 tax cut of BO only applies to Americans earning $75k or less. That might have been the line for middle class 25 years ago but it is nowhere near it now.

BS

[Amnorix]

Originally Posted by patteeu

If the democrats had really decided to "set the financial house in order" there would be nothing wrong with it. But that's not what they've done. Instead, they've decided to expand the size and scope of government dramatically while giving lip service to paying for it by attacking the rich with punitive taxes. If anyone ever really decides to set the financial house in order, one of the main components of that effort will be spending restraint. You must have forgotten that the Clinton era was benefited greatly by a significant degree of spending restraint on the part of Congress.

If only this chart helped you.



and if only the Republican TOTAL CONTROL of Congress over several years during the middle of the Bush Administration helped you even a little bit, instead of evidencing their own concept of drunken spending.

[Amnorix]

Actually, this article says it all

It is interesting to note who controlled Congress versus what party was in the presidency during the seven years that the debt was reduced throughout the terms of Truman, Eisenhower and Kennedy. Three times the Democratic Party controlled both Houses of Congress and the Presidency (1948, 1951 & 1961). The other four years all had a mix of control, with Republicans in the White House (1956 & 1957), in charge of Congress (1946 & 1947), but never both. At no time since 1945 when Republicans have been in total charge of both elected branches of government have they reduced spending. They talk about it a lot, but they never deliver.

While the debt did go up every year during Johnson’s time in office (1963-69), he was the last president before lace w:st="on">Clintonlace> to submit a balanced budget, and Johnson did this during a time of a very hot Cold War. Johnson’s average was a debt increase of 3% for the six years he served. He had a Democratic Congress to work with all his years in office.

Even Nixon (President from 1969 to 1974, when he resigned in disgrace) only had one year when he raised the debt more than 6%, 1971. His average was 5% for the six years he was in office. Between uncontrolled inflation and Ford’s conservative bend the debt increased 17% his first full year in office (1975), and 13% his second (1976). Ford’s plan to impose a policy of price controls failed to bring government overspending and inflation under control. Both these Presidents faced an opposition Congress controlled by Democrats during their time in office.

Starting in 1977 President Carter tried to control government spending even during inflationary times. The national debt increased an average of 9% per year while he was in office, and his policies eventually brought inflation under control with the help of a semi-cooperative Democratic Congress. He was thrown out of office after one term for making and implementing the hard decisions required to cut spending and deal with the energy crisis.

As President Reagan entered office in 1981 he repeatedly called for a balanced budget amendment to the Constitution, yet never submitted a balanced budget himself[7]. Many on the right reflexively blame the Democratically controlled Congress for the “big spending” during his administration, even though Republicans controlled the Senate for the first six years of his two terms. Only during the last two years of the Reagan administration was the Congress completely controlled by Democrats, and the records show that the growth of the debt slowed during this period. It appears that the frequently referenced Reagan’s Conservative mythology is contrary to the truth, he was an award winning, record setting liberal spender.

The fact is that Reagan was able to push his tax cuts through both Houses of Congress, but he never pushed through any reduced spending programs. His weak leadership in this area makes him directly responsible for the unprecedented rise in borrowing during his time in office, an average of 13.8% per year. The increase in total debt during Reagan’s two terms was larger than all the debt accumulated by all the presidents before him combined. From 1983 through 1985, with a Republican Senate, the debt was increasing at over 17% per year. While Mr. Reagan was in office this nation’s debt went from just under 1 trillion dollars to over 2.6 trillion dollars, a 200% increase. The sad part about this increase is that it was not to educate our children, or to improve our infrastructure, or to help the poor, or even to finance a war. Reagan’s enormous increase in the national debt was not to pay for any noble cause at all; his primary unapologetic goal was to pad the pockets of the rich. The huge national debt we have today is a living legacy to his failed Neo-Conservative economic policies. Reagan’s legacy is a heavy financial weight that continues to apply an unrelenting drag on this nation’s economic resources.

George Bush Sr. meekly followed in Reagan’s shadow after his election in 1988, by increasing the debt on average a mere 11.8% a year during his four years as President. In his last year in office he quite responsibly worked with Democrats to raise taxes to help reduce the massive yearly increases in the national debt. This bipartisan plan got the growth down to under 11% in 1992, but it was too little too late and didn’t make much difference in the overall trend. The Neo-Conservatives controlling the Republican Party rewarded him for putting the nation’s future above his party’s ideology by throwing him out of office even though it had hardly been a year since he won the Gulf War.

In 1993 President Clinton inherited the deficit spending problem and did more than just talk about it; he fixed it. In his first two years and with a cooperative Democratic Congress he set the course for the best economy this country has ever experienced. Then he worked with what could be characterized as the most hostile Congress in history, led by Republicans for the last six years of his administration. Yet, under constant personal attacks from the right, he still managed to get the growth of the debt down to 0.32% (one third of one percent) his last year in office. Had his policies been followed for one more year the debt would have been reduced for the first time since the Kennedy administration.

When President Bush II came into office in 2001 he quickly turned all that progress around. With the help of a Republican controlled Congress he immediately gave a massive tax cut based on a failed economic policy; perhaps an economic fantasy describes it better. The last year Mr. Clinton was in office the nation borrowed 18 billion dollars. The first year Mr. Bush II was in office he had to borrow 133 billion[8]. The first tax cut Bush pushed through a willing Republican Congress caused an upswing in government borrowing that was supposed to stimulate the economy, but two years later Bush had to push through yet another tax cut. The second tax cut was needed because it was clear that the first one did not work. Economic history tells us the second did not work either. As a result of all his tax cutting with no cutting in spending, in 2003 President Bush set a record for the biggest single yearly dollar increase in debt in the nation’s history. He did it again in 2004, increasing the debt more than half a trillion dollars. Since 2003 total borrowing has exceeded $500,000,000,000 per year. Even Mr. Reagan never increased the debt that much in a single year; Mr. Reagan’s biggest increase was only 282 billion, half of GWB’s outrageous spending. As a result of the fact that the debt was already pretty high when Bush II entered office, his annual rate of increase is only averaging 7% per year so far. In 2006 he was holding press conferences bragging that the debt was increasing at the rate of only 300 billion dollars a year, yet in reality it was twice that. Again the facts do not match Neo-Con rhetoric.

Of course 7% growth is a misleading figure as it does not make clear that by so drastically increasing the total debt, the amount of the annual lace w:st="on">USlace> budget dedicated to service the debt has grown to over 20%. Thanks to misguided Neo-Con ideological thinking, over a fifth of our budget does nothing to contribute to the growth or health of the nation.

It does not matter if you call it a war or an occupation, supporting lace w:st="on">Iraqlace> is expensive. It just boggles the imagination of any fiscally responsible person that the Republican Congress and President have repeatedly cut taxes during this overly aggressive and very expensive era for our military. The nation is borrowing money so that the we can spend more on our military than all the other nations on Earth combined, and still the Neo-Cons are calling for even more tax cuts and even more military spending.

Mr. Bush is constantly claiming that the economy is great! What he leaves out is that he is buying that simulated good economy with his borrowed dollars; it is a false economy that could very well crash the minute the borrowing stops, yet for the sake of our future it must stop.