What Bargain to Strike: Balanced Budgets and Tax Policy

“He who lives only to benefit himself confers on the world a benefit when he dies” – Tertullian

After giving up on every principled argument, conceding that he will never tolerate a disruption in government services for fear of the political consequences, and handing the reins of the budget process back to president Obama and senator Reid, Speaker of the House John Boehner wrote a strongly worded article published in USA Today (here) … that ought to strike fear in the heart. The title declares “Next fight to be about trillions, not billions” this is not encouraging. Boehner is certainly right though. The next fight, if there is to be one at all (meaning he doesn’t just lay down and hand it all over to the big-spenders) will of necessity deal with numbers in the trillions.

Given that, I thought I’d put out my preference for the outcome of that “fight” (again, if it happens at all). In a “perfect world” the outcome would be massive cuts in spending, reduction of government to its minimum necessary functions (defense of life, liberty, property), and a simplified tax code that neither plays favorites nor encourages the government to live the lives of individuals for them – but leaves us all free to make our own decisions. This dream state is, to say the least, a long way away. So, we must make a more pragmatic argument. As a general rule, I prefer:

  1. flatter taxes
  2. lower taxes
  3. lower spending
  4. balanced budgets

Perhaps we can make a charge at 3 of the 4. If I were Boehner (or Cantor or Ryan for that matter), I would give in on #2 and try to get the rest.

The Democrats will harp incessantly about “not balancing the budget on the backs of the middle class” and the rich “paying their fair share.” It is patently absurd to call any sort of progressive taxation something short of “paying a fair share” – it goes well beyond. Furthermore, the taxation system is designed to keep the wealthy in tact, while prohibiting the middle class from rising to such station – precisely because of the progressive nature of the taxation that is not matched in capital gains taxes. But this is not the point. If the Democrats are going to harp on the issue, take it away from them. Give in on taxes (not without some faux resistance, of course). In fact, shoot for higher taxes than they propose (you heard me).

First, some simple (and rough, approximate, admittedly not exact) math. The top 1% of wage earners pays around 40% of the income taxes; with the top 5% paying around 60%. The total income taxes paid are a shade over $1 trillion (from the 2008 numbers I found). OK, the top 5% pay 60% of the income taxes – or roughly $600 billion. Let’s forget about the Laffer curve for just a second … a brief second, and raise their income tax from the current top level of 35% all the way to 100%! What additional revenues are generated? If we hold all other variables constant, this generates an additional $1114 billion in revenues … not bad – but still not enough to close the $1650 billion deficit. Soaking the rich won’t do it.

Now, we know full well that these numbers won’t hold up. If you tax these folks at 100% they just won’t work any more after they hit the tax bracket boundary – and the actual income tax collected from them will mirror that of the bottom 95% – which is to say down by $200 billion – ooops.

Of course the Democrats will not propose raising the top tax rate to 100%. No, they will likely propose raising it to the rate from the idyllic days of the second Camelot (Bill Clinton) – 39.6%, or 460 basis points (4.6%) higher than the current rate. This will net, again by my rough math, maybe $79 billion more in revenues. As this number is meaningless in the face of a $1.65 trillion deficit, and since the real threat to the economy is not higher taxes but runaway spending, I suggest that the Republicans (and even the beloved Tea Partiers), simply give in on the issue. (Follow Boehner’s lead – he can show you how to do this quite effectively while maintaining a perfect television makeup tan.)

Don’t just give in – go one better. Propose adding a 4.6% “top off” to every income tax bracket. Move the 33% bracket to 37.6%; the 25% bracket to 29.6%, the 10% bracket to 14.6%, and most importantly, move the 0% bracket to 4.6% … everybody should have some skin in the game. I suspect that this would actually raise revenue in the short term (yes, long term there are always negative repercussions of tax hikes – but I reiterate that high taxes are not the main threat to the American economy, it is runaway spending – which we will address momentarily). How much revenue? Not sure. Bumping the top 5% by 12% (rate of 35% to 39.6%) is bound to have a smaller impact than bumping the rest by even more (say, 15% to 19.6% – a 31% increase in tax rate). I’m willing to ballpark this at $200 billion annual (again, short term).

More importantly, it represents a flattening of the income tax curve; give in on point #2 (lower taxes) and gain on point #1 (flatter taxes).

What of the other two. Well, they go hand in hand. After putting up a faux resistance to the oppressive tax policies, then offering a counter-punch of even higher taxes, the Republicans should demand, flat out demand, that every dollar increase in revenue be met with five dollars in spending cuts. Swing for the fences here. For the $200 billion in tax increases, demand $700 billion in cuts to entitlements – annually. Then throw the administration a bone and accept $150 billion in defense cuts along with $150 billion in other discretionary spending. That’s $1 trillion in budget cuts, with $200 billion in revenue increases. No, this doesn’t cover the full $1.65 trillion Obama deficit, but it’s a strong move in the right direction.

The tax increases are the distraction. They’re largely meaningless in the face of the runaway spending, they can be used to flatten the tax curve (a good thing), and they can be used as bait to get spending cuts and move toward a balanced budget. It’s a massive win.

Granted, nobody has the guts to move for $1 trillion in spending cuts immediately. Maybe the whole thing gets pared back some (or a lot). But trading away nominal tax increases for meaningful, generation-long spending cuts (particularly to entitlements) may be the only way to rescue the sinking ship. And I’m absolutely in favor of that.

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