May 2011

Tax Increases Will Not Solve the Budget and Debt Crisis

by John Hendrickson

Recently Standard & Poor’s Rating Service “downgraded its outlook on U.S. Government debt, expressing unprecedented doubts over the ability of Washington to bring massive federal deficits under control.”[1] The negative rating is because of the enormous fiscal crisis the nation faces with runaway government spending. Both Republicans in Congress and President Barack Obama and his fellow Democrats are offering separate policy blueprints to solve the fiscal crisis. This budget and spending debate is part of a larger philosophical debate over the size and scope of the federal government. In order to solve the fiscal crisis and restore prosperous economy, policymakers must follow a course that is rooted in tax and spending reform.

The warning from Standard & Poor’s is a result of uncontrolled government spending and this is seen not just at the federal level, but at all levels of government. Currently, the national debt is over $14 trillion and rising and the government is running deficits into the trillions. In 2009 the government ran a $1.4 trillion deficit, followed by a $1.3 trillion deficit in 2010, and a projected deficit of $1.5 trillion in 2011. President Obama has proposed a $3.7 trillion budget for 2012 and recently revised his budget to call for entitlement and spending reform.

President Obama has called for “Congress to cut deficits by $4 trillion over 12 years,” along with mild entitlement reform.[2] In addition, President Obama has called for tax increases for those earning $250,000 or more to raise revenue, which also includes the expiration of the Bush Tax Cuts. The Republican plan, which is engineered by Representative Paul Ryan (R-WI), Chair of the House Budget Committee, has called for significant spending cuts, entitlement reform, and tax cuts. The Ryan plan calls for cutting “$5.8 trillion over the next decade.”[3]

Rep. Ryan’s proposal also calls for significant tax reform including lowering both the federal corporate and personal income tax rates. In regard to the corporate tax, the Ryan plan calls for lowering the top rate to 25 percent and “eliminating some deductions and credits and scaling back others.”[4] With respect to the personal income tax the Ryan plan calls for “consolidating tax brackets and lowering personal income tax rates, with a top rate of 25 percent.”[5] The across-the-board tax reform package in the Ryan plan, if enacted, would be significant in growing the economy.

The Ryan plan also calls for reforming the entitlement programs of Social Security, Medicare, and Medicaid. In regard to Medicaid the plan would provide states with block grants, while the Medicare reform would consist of leaving the status quo for those over the age of 55, but for those younger providing them with a credit to purchase an insurance plan.[6]  This element of the reform plan is the most significant because it brings reforms to the entitlement programs that are currently facing trillions of dollars in unfunded liabilities. It should also be noted that the Patient Protection and Affordable Care Act (ObamaCare) would be abolished.

President Obama and fellow Democrats have criticized Republicans for “giving tax cuts for the rich,” while dismantling the social safety net of the entitlement programs. Former Secretary of Labor Robert Reich, in a recent op-ed titled “Why we must raise taxes on the rich,” is calling for a tax increase on wealthy Americans.[7] Former Vice President and Minnesota Senator Walter Mondale has also joined the chorus of those who are arguing for tax increases to solve the fiscal crisis. “We will not be able to control our budget deficits without raising taxes,” wrote Mondale.[8]

Professor Walter E. Williams, a distinguished scholar in the fields of economics, recently wrote:

This year, Congress will spend $3.7 trillion dollars. That turns out to be about $10 billion per day. Can we prey on the rich to cough up the money? According to IRS statistics, roughly 2 percent of U.S. households have an income of $250,000 or above…All told, households earning $250,000 and above account for 25 percent, or $1.97 trillion, of the nearly $8 trillion of total household income. If Congress imposed a 100 percent tax, taking all earnings above $250,000 per year, it would yield the princely sum of $1.4 trillion. That would keep the government running for 141 days, but there’s a problem because there are 224 more days left in the year.[9]

James Pethokoukis, a columnist for Reuters, wrote that President Obama’s plan “is actually proposing $1 trillion in new taxes on wealthier Americans (and small businesses) and $1 trillion in higher tax revenues by reducing tax breaks and subsidies for a total of $2 trillion in new taxes over 12 years.”[10]

Raising tax rates to accumulate additional revenue will not only hurt the economy, but also do little in paying down the massive national debt. The solution to the fiscal crisis must be found in cutting spending, along with lower tax rates across-the-board to encourage the private sector of the economy, which in the end will generate more revenue by expanding the tax base. Progressives and modern liberals tend to believe that higher tax rates will result in more revenue for the government. “Raise the rates too high, and you get a perverse result: less money from the rich than you expect. Lower the rates, and the rich pay a greater share of the taxes,” noted economic historian and columnist Amity Shlaes.[11]

The policy direction that President Obama and Democrats are offering is a continued progressive vision built upon the legacy of the New Deal and Great Society. This includes an expansion of the regulatory and welfare state, as well as redistributionist fiscal policies. “When government takes more than 50 percent of your income during a good year, it is extremely difficult to accumulate the assets to live a life free from the dependence upon government programs,” noted Charles Kadlec, who is an economic columnist for Forbes.[12]

The Wall Street Journal recently reported that major American business firms are increasingly hiring more workers overseas rather than on the home-front economy.[13] Businesses as well as individuals are still uncertain over the future of the economy and the current direction of fiscal, regulatory, and monetary policy. Raising tax rates will not stimulate further job creation, but rather hinder job creation. In addition, the economy’s recovery from the “Great Recession” is not fully complete, especially with the rise in inflation, the declining value of the dollar, high unemployment, and the uncertainty over resolving the massive federal debt, all of which could send the nation back into a double-dip recession.

Policymakers must realize that raising taxes will not be a sound option in solving the debt crisis. The best solution will follow a path that cuts spending, reforms entitlements, reduces taxes and regulations, and strengthens the value of the dollar. All of these policy solutions are necessary to resolve the debt crisis. The Ryan plan is a good place for policymakers to start in reforming the budget for 2012, while cutting spending. In addition, cutting tax rates across-the-board will unleash the private sector of the economy. Lowering both the corporate and income tax rates to 25 percent, as proposed in the Ryan plan, would be a pro-growth economic policy.

John Hendrickson is a Research Analyst at Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation. They are brought to you in the interest of a better-informed citizenry.

[1] Paul Wiseman, “S&P cuts long-term outlook for U.S. debt to negative,” Investor’s Business Daily, April 18, 2011, <http://www.investors.com/NewsAndAnalysis/Article/569401/201104181333/SandP-Cuts-Long-Term-Outlook-For-US-Debt-To-Negative.htm?src=HPLNews> accessed on April 18, 2011.

[2] Carol E. Lee and Damian Paletta, “President calls out GOP: Obama rips Republican deficit plan, says mix of taxes, cuts needed; foes dismayed, ”The Wall Street Journal, Thursday, April 14, 2011, vol. CCLVII, No. 86, page A1.

[3] Janet Hook and Naftalli Bendavid, “GOP passes budget cut: Blueprint for $5.8 trillion reduction clears House, setting up clash with Democrats,” The Wall Street Journal, Saturday/Sunday, April 16-17, 2011, vol. CCLVII, No. 88, page A1.

[4] Lee and Paletta, page A4.

[5] Ibid.

[6] Ibid.

[7] Robert Reich, “Why we must raise taxes on the rich,” The Des Moines Register, Thursday, April 14, 2011, page 11A.

[8] Walter Mondale, “As in 1984, we need the courage to raise taxes,” The Washington Post, April 15, 2011, <http://www.washingtonpost.com/opinions/walter_mondale_as_in_1984_we_again_need_the_courage_to_raise_taxes/2011/04/14/AFxVSSkD_story.html?wprss=rss_homepage> accessed on April 18, 2011.

[9] Walter E. Williams, “Eat the Rich,” Creators Syndicate, April 13, 2011, <http://www.creators.com/conservative/walter-williams/eat-the-rich.html> accessed on April 19, 2011.

[10] James Pethokoukis, “Obama’s $2 trillion stealth tax hike,” Reuters, April 17, 2011, <http://blogs.reuters.com/james-pethokoukis/2011/04/17/obamas-2-trillion-stealth-tax-hike/> accessed on April 19, 2011.

[11] Amity Shlaes, “Get rich, pay lower taxes, boost U.S. Revenue,” Bloomberg, April 18, 2011, <http://www.bloomberg.com/news/2011-04-18/get-rich-pay-lower-taxes-boost-u-s-revenue-commentary-by-amity-shlaes.html> accessed on April 19, 2011.

[12] Charles Kadlec, “Obama’s plan for a fundamentally different America,” Forbes, April 18, 2011, <http://blogs.forbes.com/charleskadlec/2011/04/18/obamas-plan-for-a-fundamentally-different-america/> accessed on April 19, 2011.

[13] David Wessel, “Big U.S. firms shifting hiring abroad,” The Wall Street Journal, April 19, 2011, <http://online.wsj.com/article/SB10001424052748704821704576270783611823972.html?mod=djemTMB_h> accessed on April 19, 2011.