Just a Little Tax Hike ...

Kevin Drum doesn't think it will be so hard to solve our fiscal problems with tax hikes:

I said that federal taxes had averaged 21% of GDP over the past 30 years, and Ross correctly points out that it's federal spending that's averaged 21%. On a macro level this might or might not matter ("to spend is to tax"), but it does matter if we're trying to figure out how voters will react to an increase in the total tax take. However, I continue to believe that the impact would be much less than Ross thinks. The federal tax take was around 20% of GDP during the Clinton era, so here's what we're talking about: letting the Bush tax cuts expire in a couple of years and then raising tax rates by about four or five points of GDP over the next 20 or 30 years. Done reasonably and fairly, I just don't believe that an increase this gradual would be wildly oppressive.

This is not true, and it's important to point out why it's not true.  First of all, while it is technically true that the federal tax take was "around 20% of GDP" during the Clinton era, this was only true at the height of the stock market bubble.  Tax revenues exceeded 20% of GDP for exactly one year: 2000.  The average tax take under Clinton was 19%.  And if you exclude 1999 and 2000, the very height of the bubble, it was more like 18.5%.

Without arguing about whether our tax system is fair or not, the fact is that the federal income tax is the most variable part of the code, and the federal income tax is now very progressive; it collects most of its revenue from people at the top.  (Whether it should collect even more is an argument for another day.)  Because it collects most of its income from people at the top, and because the incomes of the wealthy are more variable than the incomes of the poor and middle class (Warren Buffett's income can drop by $300,000; mine can't), we're going to get deep troughs in recessions, and high peaks in boom times.  We will get particularly high peaks when the booms are delivering huge chunks of income to a handful of people in a very short timeframe.  According to the CBO, capital gains receipts alone, which more than doubled in Clinton's second term, accounted for more than 30% of the increase in income tax receipts above the rate of GDP growth.  Obviously the ancillary ordinary income, like banking fees, also contributed substantially. Between 1996 and 2000, payroll taxes increased a tidy 30%.  But income taxes increased by 55%.  In 1996, social insurance receipts were about $500 billion, while income tax receipts were $650 billion.  By 2000, payroll tax receipts had grown to $656 billion--but the income tax was collecting over a trillion.  Today they're roughly at par again (though that won't last--social insurance contributions will drop as the worker to population ratio declines.)

Saying "all we have to do is go back to the tax rates under Clinton" is effectively saying "all we need is another asset price bubble that funnels a huge amount of money into the pockets of the rich".  This seems neither particularly feasible, nor desirable. 

If we pick, somewhat optimistically, the mean tax take of the Clinton years, that means that we need a tax hike of 5-6% of GDP.  And not over 20-30 years.  The CBO's baseline projection of the budget deficit, which assumes that the Bush tax cuts expire (and that the AMT is allowed to hit middle class incomes, and that the "doc fix" doesn't happen), is for budget deficits in the range of $750 billion. If you allow the Bush tax cuts to expire, but assume that we are not going to slash Medicare reimbursements for doctors by 30%, or let the AMT hit people making $75,000 a year, then it's more like $900 billion.  If you assume that discretionary spending grows roughly in line with nominal GDP, it will be $1.2 trillion.  Maybe that's only 5% of GDP by 2021.  But it's still not a healthy and sustainable level of borrowing; we're going to have to raise taxes pretty quickly.

A tax hike of 5-6% of GDP doesn't sound like much.  But that's a big tax hike if your baseline is 19%--it means that everyone's taxes go up by about a third.  If the equilibrium tax revenue at Clinton rates is more like 18-18.5% of GDP, then obviously, they have to go up even higher, from a lower baseline. If you try to concentrate the pain on the wealthy or corporations, it's an even bigger whack.  Meanwhile, state and local taxes will be going up too; they have many of the same pension and entitlement problems that the federal government does.

These aren't little adjustments.  They're huge changes in the overall tax burden, and they will have big effects on peoples lives, and the economy.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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