Capitol Ideas

Taxes Won’t Save Us

Chop-logic from Wonderland.

By From the October 2012 issue

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OVER THE YEARS I HAVE WRITTEN quite a few budget articles. Then I stopped because the readers stopped. Budget numbers are dull, and complications quickly multiply. Most people have a hard time keeping their family’s budget straight, let alone the federal government’s. That’s a pity, because America’s financial picture today is grave.

A thousand Internet commentators are predicting a crash (without saying when). In contrast, Democrats downplay the issue because they believe our problems can be solved by raising the tax burden on the rich. With class warfare his main preoccupation, President Obama seems obsessed by the idea that he has a golden opportunity to punish the productive. But if he gets his way, the budget picture may well go from bad to worse.

Here’s my one-paragraph sermon on budget basics. Tax rates are prices. Taxes are quantities. Yet they are frequently conflated, as in the phrases “tax cut” and “tax increase.” When tax rates are increased, what happens to revenues? The Congressional Budget Office assumes that they go up by the same proportion. But they don’t. Imagine you are running a money-losing department store, and everyone gives you the same advice: “Raise prices on your luxury goods!” So you do, and the rich shoppers go somewhere else. Now you are worse off. Prices higher, revenues lower. You have learned a lesson. When it comes to prices (or taxes), the rich can move, or move their money, or both.

Unfortunately, confused readers generally work to the advantage of liberals, whose permanent goal is to expand the power of government. As a rule, reporters draw attention to national budget problems only to persuade us that “more taxes” are needed. They mean more revenues, and they assume higher tax rates will produce them.

Spending cuts are equally misreported. Assume that $100 is being spent on some government program (think of it as $100 billion if you want to be more realistic). Now a “5 percent budget cut” is promised—but it’s not what you might imagine. Capitol Hill has 10-year budget projections already built in. So Congress has scheduled, let’s say, $110 (billion) for the same program next year (a 10 percent increase). Under a 5 percent cut, only $105 will be allocated to the program instead of the projected $110.

So in the end, spending has gone up from $100 to $105 and that’s a 5 percent cut. So it goes. Reporters who write these stories never tell you that a budget “cut” is almost always an increase that has been slightly reduced from an earlier “baseline.” In the end, only the budget wonks understand what’s going on.

That’s where vice presidential candidate Paul Ryan comes in. He has a better understanding of these things than any congressman I have ever met or heard of. (David Stockman was pretty good too, 32 years ago, until he became strangely radicalized.) What’s more, Ryan knows how to explain the issues so that non-experts know what he’s talking about.

You may have heard that we are facing a “fiscal cliff.” Many tax-rate increases and spending cuts are due to take effect unless Congress changes the law. Bush-era tax changes, some going back 10 years, and various others, will expire on December 31 if nothing is done. Tax rates on income, dividends, and capital gains will all go up in the new year; capital gains, for example, to 30 percent from the current 15 percent; dividends to 44 percent from 15 percent. Plus there will be a big increase in the death tax, known as an estate tax. (For a full list of the tax increases slated for next year, see Grover Norquist’s “Waiting for Taxmageddon,” TAS, July-August 2012.)

The CBO assumes no behavioral change in response to these tax hikes, which is like assuming that human targets won’t budge when a pistol is visibly aimed at them. The government assumption is that with these higher tax rates, $500 billion in new revenues will be collected. Spending cuts are also due to take effect, in a budget “sequester.” The defense budget in particular will take a big hit.

The combined effect of these changes is supposed to be a $600 billion deficit reduction. That’s another deceptive phrase, by the way—“deficit reduction.” The unwary assume it means a reduction in the budget when what it usually really means is that your taxes are going up. In 1990, President Bush (Sr.) called for “deficit reduction,” and he got what his aide Dick Darman wanted—a tax increase. That broke Bush’s “no new taxes” pledge and cost him the 1992 election.

Current government spending for 2012 is $3.8 trillion, and the deficit is said to be $1.3 trillion. So enactment of these fiscal changes will (supposedly) almost halve the current budget deficit. But don’t believe that. Meanwhile, estimates of government debt vary widely. A figure commonly given is $15.5 trillion. Former U.S. Comptroller David Walker puts the figure at $70 trillion— which counts promises made to seniors and pensioners— and growing by $10 million every minute. Economist Laurence Kotlikoff and columnist Scott Burns report a long-term “fiscal gap”—which they define as the “difference between projected future spending and revenue”—of $223 trillion. The key point: Debts are growing faster than revenues.

AS TO CURRENT NEWS, the most recent CBO assumption is that if Congress does nothing before January—so that we really do fall off the fiscal cliff—the combined effect of the rate increases and spending cuts will push us back into a recession in 2013. And that is quite plausible.

This summer, the GOP-controlled House did pass a bill postponing all impending tax increases for a full year, but Obama promised a veto. The Senate delayed most of these increases, except for individuals with incomes above $200,000 and for families over $250,000. That’s what Obama wants. The belief in Washington now—at the end of August—is that Congress will do nothing in October and even that the prevailing disagreement might persist, creating an impasse throughout the lame duck session.

Some Democrats, notably Sen. Patty Murray of Washington, have proclaimed their willingness to sail off the fiscal cliff. But others have warned that this could create great economic uncertainty before the election—hazardous for Obama. So it could be that Democrats will swallow their pride and move in October to postpone the fiscal cliff for everyone, for a full year. Markets would jump, and only the hard left would be indignant. Possibly Obama would join them, because punishing the rich seems to be his goal in life.

The familiar method of eroding government debt is by inflation. Germany did that in the early 1920s. Here, the Federal Reserve can buy government bonds with dollars created out of thin air. No one is charged with counterfeiting, and bank balance sheets are improved. But savers are punished because dollars become ever less valuable.

But there’s a new element today. Governments can only inflate away their debt if lenders are unwary. Today, market participants are more alert than ever. If incipient inflation is spotted, “bond vigilantes” demand a higher interest rate to compensate for the dollar’s decline. This makes inflation more problematic. Rapidly rising interest rates—they are historically low right now—would soon overwhelm the federal budget. Which means that the Fed has to be careful about its money creation.

Lewis Lehrman, chairman of the Lehrman Institute and normally an optimist, has referred to America’s “dire and deteriorating position as a massive debtor,” propped up “by the exorbitant privilege of the dollar’s role as a global reserve currency.” Our private national wealth, he adds, “has been indirectly pledged as collateral for U.S. government debt and its enormous unfunded liabilities.”

The main problem has been our endless expansion of debt, and the assumption by Democrats and the media that once spending is pushed through, as happened with TARP in 2009, the GOP is trapped. It will have no option but to “raise taxes” to keep pace. The increase in spending is treated as a ratchet that can move only in one direction.

An underlying problem is the tax code, which rewards debt (with tax breaks) and punishes savings (with taxation and inflation). Those incentives should be reversed. But wait, that would help “the rich”…

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About the Author

Tom Bethell is a senior editor of The American Spectator and author of The Politically Incorrect Guide to Science, The Noblest Triumph: Property and Prosperity Through the Ages, and most recently Questioning Einstein: Is Relativity Necessary? (2009).