Julie Ni Zhu / Debt is a spending issue, not a tax issue - pressofAtlanticCity.com: Commentary

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Julie Ni Zhu / Debt is a spending issue, not a tax issue

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Posted: Monday, September 17, 2012 12:01 am

Julie Ni Zhu / Debt is a spending issue, not a tax issue

Raising taxes to address mounting U.S. debt is not really an option. While it may seem fair politically, it is unrealistic and counterproductive in practice.

In the 67 years since the end of World War II, the top marginal income-tax rate has varied widely, from a high of 92 percent in 1953 to a low of 28 percent from 1988 to 1990. Corporate taxes also have moved up and down during the post-war years, ranging from a high of 53 percent to a low of 35 percent.

Whether the rates have been high or low, however, during the entire nearly seven-decade period, federal receipts have averaged 19.6 percent of gross domestic product. In fact, they exceeded 20 percent of gross domestic product only once, in fiscal year 2000, during the tech boom, when they reached 20.6 percent of GDP. The top income tax rate then was 39.6 percent.

What this means is that higher tax rates do not increase federal revenues and are not a cure-all for the budget deficit.

Instead, when tax rates are increased, individuals and businesses tend to react by postponing income, finding tax shelters, moving assets offshore, and hiring armies of accountants and lawyers to protect their income. Higher taxes also can slow the economy by reducing the personal rewards for working, innovating and investing.

Instead of increasing tax revenues, as intended, higher tax rates reduce the size of the tax base. And we end up exactly where we were.

The deficit problem, therefore, is a spending problem. If revenues equal 20 percent of GDP, which is the historical post-war norm, and spending exceeds 24 percent of GDP - as it does now - we will continue to run huge deficits, which will add to the national debt.

Earlier this month, the debt hit a record $16 trillion. Federal spending, meanwhile, hit 25.5 percent of GDP last year, in fiscal 2011, and is expected to exceed 24 percent this year, with a projected $1.33 trillion deficit. The proposed fiscal 2013 budget, meanwhile, projects a deficit of "just" $901 billion.

The lesson we should learn from this is simple: At some point, apparently around 20 percent of GDP, increased tax rates are offset by shrinkage in the tax base. If a 25 percent increase in the tax rate is met by a 25 percent decrease in whatever the government is taxing, there is no net tax increase to the Treasury.

The history of U.S. taxes and spending shows that once expenditures rise above 20 percent of GDP, no level of taxing will pay for it.

It is true that higher taxes have succeeded in increasing government revenue in small, homogeneous countries such as Sweden and Finland. With the large, diverse, and often fractious population of the United States, it just doesn't work here.

Julie Ni Zhu is a research analyst at the American Institute for Economic Research.

Posted in on Monday, September 17, 2012 12:01 am.

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