With all eyes on Europe as France and Spain struggle to close their budget deficits while global markets anxiously wait for a final Greek exit to put a hole in the Eurozone, things seem quiet on the fiscal policy front here in the United States, but brewing under the surface is another big fiscal fight over the national debt, yearly budget deficit, and the debt ceiling.
One relevant principle in economics is the observable phenomenon that increasing tax burdens hinder an economy’s outputs. In 1913, passage of the 16th Amendment permanently embedded the income tax into our lives, but the seemingly counter-intuitive inverse relationship between taxation rates and tax revenues ever since is well documented. Regardless of marginal rates, tax revenue as a share of GDP remained static in a narrow range of 18-20%, even in the 1960s when the top marginal tax rate was 90%:
Graph via AmericanThinker.com
These are interesting figures for a nation founded on resistance to unpopular taxes. At the Wall Street Journal, W. Kurt Hauser summarizes: “Tax revenues as a share of GDP have averaged just under 19%, whether tax rates are cut or raised. Better to cut rates and get 19% of a larger pie.” If we eliminate the cable news, split screen, partisan mentality from the equation and focus on the numbers, it becomes apparent that we just can’t tax our way to a balanced budget. Economist Antony Davies explains:
“[T]he richest 5 percent of Americans already pay a tax rate almost three times higher than the average tax rate of the remaining 95 percent. It’s hard to argue that the richest aren’t paying a fair share of taxes. Aside from that, for the richest Americans to shoulder the deficit, we would have to raise their effective tax rate to 88 percent. At 88 percent, a family earning $300,000 each year has only $36,000 after taxes—less than the average American earns.”
“The budget deficit is so large that there simply aren’t enough rich people to tax to raise enough to balance the budget.”
Moreover, even if we could eat the rich, the accumulated windfall tax revenue would still end up in the hands of bureaucratic central planners under the false pretense that a single planner can act as an architect of the economic activity of millions of market actors. In The Theory of Moral Sentiments (1759), the founder of modern economics as we know it, Adam Smith describes this behavior by a “man of system”:
“[Such a man is] apt to be very wise in his own conceit; and is often so enamored with the supposed beauty of his ideal plan of government that he cannot suffer the smallest deviation from any part of it.”
Economist James Otteson explains Smith’s “man of system”:
“The man of system faces a problem: individual people are not chess pieces to be moved only under someone else’s authority. Individuals make their own decisions and move on their own. When individuals are constantly butting up against demands from the government that they find imposing or contrary to their desires, Smith says, ‘society must be at all times in the highest degree of disorder.’”
But again, our history of marginal tax rates and total federal revenue as a percentage of GDP shows that rather than focus on taxes and revenue, getting the fiscal house back in order requires a sober assessment of the bipartisan spending problem. An intellectually honest dialogue about entitlements, a third rail of American politics, must occur at the national level. In their current structure, spending on programs like Medicare and Medicaid will engulf the budget in the next couple of decades. Any expectation of receiving future benefits from these programs requires serious, immediate cuts.
Mathematically, this perpetual runaway spending is simply not sustainable. No level of taxation will be able to keep it going, as the data above show.
I have a feature column called “Current Economics” in the new quarterly magazine, Middle Tennessee Home & Garden. What does one have to do with the other? Well, the mag is geared towards luxury home owners that have a buck or two in the bank and want to protect their net worth against unsustainable debt and worthless paper money.
Hope you enjoy.
With the Super Committee’s failing, Veronique de Rugy explains why we have nothing to fear from the sequester cuts. Even though the cuts have little effect on the growth of debt, as evidenced by this chart, Ms. de Rugy doubts they’ll even be implemented:
…[H]ere is what makes me particularly grumpy: The American people can’t even count on this tiny debt reduction, because it is unlikely that Congress and the president will let the sequester cuts be implemented — in other words, you can pretty much forget about the red bars. Of course, even the blue bars are rosy projections of our debt levels, since they assume that the spending cuts in the health-care bill will happen and that Congress will let the spending caps in the BCA work, among other optimistic expectations.
The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.
According to a Bloomberg report:
The U.S. immediately lashed out at S&P, with a Treasury Department spokesman saying the firm’s analysis contains a $2 trillion error. The spokesman, who asked not to be identified by name, didn’t elaborate, saying the mistake speaks for itself.
The United States is $14.3 trillion in debt and counting. I won’t elaborate because the mistake speaks for itself.
Here is a letter to the Sun-Sentinel:
Brian E. Little needs to brush up on his economics and American history with respect to taxation and the policies of Alexander Hamilton (Redistribution of wealth is good for social stability, August 1). Although Mr. Little asserts wealth redistribution “protects capitalism, wealth and workers,” there is no greater threat to a vibrant free market economy than a progressive income tax.
Invoking Alexander Hamilton, Mr. Little seeks to make a champion out of possibly the greatest stain on American economics. Hamilton is the original top-down central planner in America, whose First Bank served as a template for the Federal Reserve – two organizations antithetical to the principles of free markets. His policies of accumulating and consolidating debt to establish American credit set a dangerous precedent that currently finds us in a $14.3 trillion hole.
Furthermore, progressive income taxes restrict economic liberty and stifle growth – contrary to Mr. Little’s claims. Taxation based on consumption proved the best mechanism for enhancing wealth and providing certainty to markets so all could prosper, as inflation was essentially zero from 1783 until 1913. Is it any coincidence that the value of the dollar is on a steady decline since 1913 – the year the income tax became a permanent fixture in the tax code and the passage of the Federal Reserve Act?
If Mr. Little is so certain that Hamiltonian central planning, redistribution of wealth and progressive income taxes are good for business, social stability and national security, then why is the nation teetering on all fronts?
Craig D. Schlesinger
Here is a letter to the Sun-Sentinel:
Noelle Nikpour is absolutely right to point out to European nations and American liberals that big government is the root cause of crises brought on by unsustainable levels of debt. However, to maintain that conservatives are steadfast, stalwart enemies of big government and that Republicans adopt the policy prescriptions of cutting spending and privatization is pure partisan propaganda (Debt crisis: Big government remains big problem, July 24).
Was Ms. Nikpour paying attention to American politics during the eight years George W. Bush spent in the White House? During Bush’s presidency, when Republicans controlled both houses of Congress for the majority of the time, the size and scope of government grew to unprecedented levels. Under Republican controlled Washington we saw federal spending on education soar to its highest levels ever, a new prescription drug benefit program, stimulus packages, federal bailouts of private businesses, two wars, and the massive expansion of the national security state. Government spending and accumulation of debt was the modus operandi, and you call that limited government?
Big government policies as a bipartisan affair led to the debt problems we now face. Both parties are equally guilty and complicit, and to suggest otherwise is disingenuous.
Brad R. Schlesinger