Last Wednesday’s Wall Street Journal had a chart on the front page that showed very clearly the problem our country is facing.* The chart compared President Obama’s plan for government spending (and taxes) for the next ten years (based on the President’s 2012 budget proposal) with Representative Paul Ryan’s plan. (Representative Ryan is the Republican chairman of the House Budget Committee.) Here is the chart:
Representative Ryan’s plan is on the right. As you can see, Representative Ryan’s plan does not get to balance in the next ten years, though it does get the deficit down to about 1% of GDP.
But for today, I want to focus on President Obama’s plan. As you can see, the President’s plan never gets there in terms of the deficit. Even after ten years, the deficit is still 3% of GDP – and it is starting to grow again. That’s not going to work.
Compare the projected revenues in President Obama’s plan versus the revenues in PauI Ryan’s plan. The revenues under President Obama’s plan are a little higher, maybe 3/4% of GDP per year more.
Then look at spending. Representative Ryan wants to keep federal government spending at 20% of GDP each year. With taxes equal to 19% of GDP, you get an annual deficit of about 1% of GDP. President Obama, however, wants spending at 23%/24% of GDP – and growing. Since he is projecting taxes at 20% of GDP, that puts his deficit at 3% to 4% of GDP – and growing.
Given all that President Obama wants government to do, and given that he has proposed nothing yet with respect to getting entitlement spending under control, it is not surprising that President Obama’s plan has spending at this level. In fact, given all the additional people he is going to be covering with government-paid-for health care, along with the natural increases in other entitlement spending (because of us baby boomers), you sort of wonder if government spending won’t be more than the 23%/24% of GDP that President Obama is projecting. (I realize President Obama thinks his health plan is going to save money while covering more people because of more efficiencies, lower reimbursement rates to providers, less spending on unnecessary treatments, etc., but I do not have a lot of confidence in that coming true. I try to save my fantasies for baseball.)
In any case, if President Obama wants the federal government to spend 23-24% of GDP (or more), taxes are going to have to be more than 20% of GDP. So where is the President going to get this money – besides taxing the rich, of course?
Greg Mankiw recently linked to a chart comparing how progressive the income tax systems are in a number of OECD countries. Somewhat surprisingly (for at least some people), the chart shows that, compared to other countries, the U.S. already has one of the more progressive income tax systems. That doesn’t mean that the Obama administration won’t try to use the “tax-the-rich/they’re-not-paying-their-fair-share” argument to make it even more progressive. However, the problem with such an approach, as former UK Prime Minister Tony Blair noted, is that “in my experience the very wealthy can make their own arrangements.”
You can raise taxes on the rich, but that does not mean that, over a period of time, you can collect all that much more money from them. If tax rates are raised, the rich will start playing all kinds of tax planning games to avoid taxes. And with private self-interest being what it is, the rich will figure out ways to organize and structure their income to minimize their taxes faster than Congress will be able to close those “loopholes”.
There are really just two places where we can get the kind of money necessary to pay for the spending that President Obama wants. A comment at Greg Mankiw’s blog tells how European governments raise the money to pay for the social benefits they provide: a value added tax. Obviously, that would hurt the poor and middle class more than the rich, because VATs are regressive, but that’s how the Europeans get the money.**
There is one other place that we could get the money (or at least a part of the money) to pay for the level of spending President Obama wants. We can raise the income tax on people who have money, but don’t have so much money than it is worth their while to pay big bucks to experts to help them avoid/minimize their income taxes. Who’s that? The middle class. The two-year extension of the “Bush tax cuts” for those making over $250,000 a year ($200,000 if single) that was passed by the lame-duck Congress in December reduced tax revenues by an estimated $75-$80 billion over two years. (Here.) That’s about $40 billion a year. While that is real money, it’s not going cover the kind of deficits that President Obama is talking about running. It would be a start, but there are going to need to be a lot of other tax increases, too.
On the other hand, the extension of the Bush tax cuts for those making under those limits reduced tax collections by $385 billion over two years, over four times the amount you get by taxing “the rich”. But even this amount plus the amount you get by taxing the rich isn’t going to pay for what President Obama has proposed.
So what is the purpose of this post? Basically to say that, if you want the federal government to do all the things that Barack Obama and the liberal Democrats in Congress (see, for example, Nancy Pelosi) want it to do, taxes are going to have to go up.*** And the increases are going to be on more than “the rich”. They are going to be on the middle class, too – because there is where most of the money is. And because, unlike butterflies, government is not free.
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* Naftali Bendavid, Jonathan Weisman and Carol E. Lee, "Budget Talks Head to Brink," The Wall Street Journal, April 6, 2011.
** On a both unrelated and related point, a commententator quoted at Greg Mankiw’s blog gives one possible explanation why there is less inequality in Europe even though their income tax systems are less progressive than ours:
“In fact, the US system of direct taxes actually reduces inequality more than any other country as well. But overall, the USA reduces inequality a lot less than most other countries, because the other thing that you need to take into account is what taxes get spent on.
Now the US system of social security and cash benefits reduces inequality by less than any other OECD country except Korea. The US social security system is marginally less progressive then the OECD average, but the level of spending is very low – only Mexico and Korea spend less in the OECD.
So while the US tax system is progressive and reduces inequality, the US welfare state is much less effective at reducing inequality. And because the US has a very unequal distribution of income from capital and a much wider wage distribution than many other OECD countries, it ends up as a relatively unequal country after taxes and benefits.
If you look at Nordic countries, they all have much less progressive tax systems than the USA, but they collect a lot more in taxes (including in VAT). They then spend this much higher tax revenue on social security and services, and it is this side of the equation that is most important in reducing inequality.”
*** I am sure that some Democrats think they will be able to save a lot of money by reducing defense spending once we pull out of Afghanistan (and assuming we don’t do too many Libyas). It was a decrease in defense spending that helped give Bill Clinton his surpluses in the late 1990s. Liberal Democrats may be planning on that happening again. However, as I said above, I reserve my hope and fantasies for baseball.
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