Tuesday, March 16, 2010

Americans Would Have To Double Income Tax To Close 2010 Deficit

According to the Tax Foundation, the government would have to more than double income taxes to close the 2010 budget deficit. While an extreme tax hike is very unlikely, these claims show the severe imbalance of government revenue and liabilities. See the following post from The Capital Spectator for more on this.

Supply side economics guru Arthur Laffer co-authored a book recently whose title is anything but subtle: The End of Prosperity: How Higher Taxes Will Doom the Economy--If We Let It Happen. This provocative title came to mind after perusing some freshly minted numbers from the Tax Foundation, which estimates what it would take to close the U.S. government’s fiscal 2010 budget deficit by adjusting federal income tax rates for individuals. That's not going to happen, of course. Not even close. But it's an interesting way to consider what we owe and what it would take to pay off the debt solely on the backs of individual tax payers--in one year. In this make-believe world, the adjustment, of course, would be an increase in tax rates, and by more than a trifling amount. So it goes when liabilities exceed revenue by something approaching biblical proportions.

One can debate the Tax Foundation’s assumptions, of course. And in the real world there are other means of closing the budget deficit. In fact, there’s no legal pressure to close it this year, or any time soon, for that matter. Economic reality imposes its own restrictions and limits, but that’s another matter. Meantime, here’s how the Tax Foundation summarizes its theoretical experiment:

Assuming deductions, exemptions and credits were kept the same as they are now, Congress would have to raise each personal income tax rate by a factor of almost two and a half to erase the 2010 deficit. Even in later years when the President's Budget predicts that the deficit will be "only" in the $700-to-$800 billion range, the rates necessary to close the deficit are untenable.
The CBO projects a budget deficit for fiscal 2010 of $1.3 trillion. According to the Tax Foundation, blotting out that red ink by way of higher personal income taxes—all in one year—would require more than doubling the current tax rates. For the upper income levels, a near tripling of the tax burden would be required, as the table below shows.



The chances of Congress raising tax rates to close the deficit in one year, much less having the President sign off on the idea, is about as likely as waking up on Saturn tomorrow morning. The Beltway boys and girls don’t usually favor politically self-destructive legislation. If anything, they’re partial to the opposite spectrum of legislative activity, which is part of what got us into this deficit trouble in the first place.

Yes, higher tax rates are coming, and may already be bubbling before they're formally announced, as we discussed last week. But higher rates are likely to come quietly in the night, as opposed to dropping out of the blue on Monday morning with a formal press conference announcing the change on the front steps of the Capitol. No doubt there'll be other changes, too, including cutting back on certain spending projects that lack a large and influential constituency, i.e., something other than Medicare, Social Security, etc.

In any case, the Tax Foundation’s quantitative “what if” review is a reminder of just how deep a hole that’s been dug and what it would take to climb out. Assuming we even try. History suggests that printing money is the political path of least resistance. And for good reason: it works, at least until the next election. And even then, there are limits, which is to say that it works until it doesn’t.

For the moment, the bond market has a high level of tolerance for fiscal impropriety. That’s largely a function of the political cover that flows from the deflation/disinflation blowback generated by the Great Recession. But tomorrow, as Scarlett once said, is another day. So too is what passes for tolerance.

This post has been republished from James Picerno's blog, The Capital Spectator.

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