We Can’t Tax Our Way Out of This Debt Mess

So, once again, it appears from his little speech today that President Obama believes we are simply not taxed enough.

Thanks to C4P Reader Maria K. Poirier, of Rochester, Minn., for sending along her recent letter to the editor, that explains the folly of President Obama’s “Let’s Raise Taxes on the Rich” canard. Until we address entitlements, we’re offering a sponge to Katrina.

A misconception coming out of the debt-ceiling debate is that our debt problems would be solved if we raised taxes on the wealthy. If only it could be so simple.

According to the 2009 Social Security and Medicare Trustees Report, the unfunded liability (government IOU’s) of Social Security and Medicare was $106 trillion. In order to pay for these entitlements, the CBO estimated that the lowest marginal tax rate of 10 percent would have to rise to 26 percent, the 25 percent marginal tax rate would have to rise to 66 percent, and the top tax rate increased to 92 percent!

Who would bother rolling out of bed in the morning knowing that 66 percent to 92 percent of your daily wages were going to the federal government? Our economy would collapse under the weight of such a heavy tax burden.

The 2011 Trustees Report estimates Medicare liabilities to be much lower than in previous years, due to reforms under the Affordable Care Act. These reductions are based on the improbable assumption that physician reimbursements will be cut by 30 percent, and hospital payments will drop below Medicaid rates.

So, even if Congress took Buzz Lightyear’s motto and raised taxes “to infinity and beyond,” we will not solve the debt crisis or stop massive cost-shifting to Americans with private insurance.

Back in April, Cato Institute’s Alan Reynolds also exposed the “tax the rich” folly:

This insistent desire to raise taxes — which [Obama] repeated in a speech yesterday while complaining about “trillions of dollars in … tax cuts that went to every millionaire and billionaire in the country” — is a distraction. It won’t solve our nation’s fiscal problem.


Even if the president could persuade Congress to enact all of his proposed tax increases, in addition to surtaxes already included in ObamaCare, the CBO finds we would still face endless budget deficits averaging 4.8% of GDP.

“Federal debt held by the public would double under the President’s budget,” says the CBO, “growing from 69% of GDP at the end of 2011 to $20.8 trillion (87% of GDP) at the end of 2021, adding $9.5 trillion to the nation’s debt from 2012 to 2021.”


And yet, enormous as they are, these deficit and debt estimates assume that the higher tax rates called for under the president’s 2012 budget plan do no harm to the economy, that interest rates stay unusually low, and that the economy avoids recession for a dozen years. Those assumptions require taxpayers to behave much differently than they ever have before.


It is not as though we have never tried high tax rates before. From 1951 to 1963, the lowest tax rate was 20% to 22% and the highest was 91% to 92%. The top capital gains tax rate approached 40% in 1976-77. Aside from cyclical swings, however, the ratio of individual income tax receipts to GDP has always remained about 8% of GDP.

The individual income tax brought in 7.8% of GDP from 1952 to 1979 when the top tax rate ranged from 70% to 92%, 8% of GDP from 1993 to 1996 when the top tax rate was 39.6%, and 8.1% from 1988 to 1990 when the highest individual income tax rate was 28%. Mr. Obama’s hope that raising only the highest tax rates could keep individual tax receipts well above 9% of GDP has been repeatedly tested for more than six decades. It has always failed.


Both individual income taxes and overall federal taxes have long been a surprisingly constant percentage of GDP — 8% and 18%, respectively — regardless of top tax rates on salaries, small business and investors. It follows that the only reliable way to raise real federal revenues over time is to raise real GDP.

And then there is this interesting essay over at American Thinker this week:

Common sense, and past history, shows that increasing tax rates can cause people to not invest and even Obama, in August 2009, said it was bad economics to raise taxes in a recession.

When people aren’t spending, increasing their taxes will just cause them to spend less and worsen the overall economy.  But worsening the economy shrinks the tax base and hence can result in lower revenues, even if the tax rates have been increased.

While increasing rates on the 51% of Americans who pay federal income taxes helps no one other than the government, growing the economy and increasing the tax base provides new wealth for all Americans.

Raising taxes on the 49% of Americans who don’t currently pay taxes might raise revenue but at a huge expense to the economy.  The majority of those who don’t pay taxes don’t have large amounts of disposable income.  Increasing their tax rates would force them to reduce spending and hurt the economy.

While in the interest of fairness it may be good to ensure that all working Americans pay taxes now is not the time to add that drag to the economic equation.

Hence it would seem clear that increasing rates shouldn’t be the choice of first resort.  Not because of any concern about fairness but simply because increasing rates has a good chance of not actually increasing revenue.

Conservative economists have historically pointed to an obvious conclusion.  At some tax rate the revenues start going down.  This is just common sense.  If the economy is going well and the tax rate is 0% increasing it to 2% will probably increase government revenue.  But if the economy is bad, so that people don’t have a lot of money for investment, and the tax rate is 98%, raising it to 100% would probably reduce government revenues.

Capitalism works because human beings are willing to work hard if they can in return get rewarded.  Increasing the tax burden beyond some point reduces the reward to the point that a lot of people won’t put in that extra effort because the reward is just not worth it t them.

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