The Spectacle Blog

Notes on the Cliff

By on 1.3.13 | 8:50AM

On his blog, Confounded Interest, GMU finance professor Anthony Sanders dryly notes that the American Taxpayer Relief Act does nothing of the sort. As he puts it, "How is adding $4 trilion to the federal deficit in 10 years called, 'relief'?" 

Depending on how much money you earn, the bill may bring some temporary "relief" from the sting of higher marginal tax rates on household and family income. Or it may cause you immediate stress. Stephen Entin of the Tax Foundation lays out the tax provisions and scores their effects on the U.S. economy.

  • The top estate tax rate has been raised to 40 percent.
  • The top rate on individual income is up to 39.6 percent from 35 percent
  • and the capital gains and dividend rates have been raised to 20 percent.

On a static basis (without behavioral effects taken into account) Entin calculates this will raise $82 billion in revenue per year. Once economic effects are considered, the measures will raise only $29 billion. He concludes that for every $1 in revenue raised, GDP will fall by $8.50.

With tax rates raised on those earning over $400,000 some may imagine that only a rarified tier of high earners will be forced to fork over more income to the federal government. However, tax increases in this category also includes small businesses. These hikes will affect decisions over hiring, expansion, and wages. The outcome -- slower economic growth for all.

And in the bargain it's paltry revenue considering our fiscal path. Factoring in the Social Security and Medicare Trust Funds, the U.S. has amassed $16.3 trillion in total gross debt representing 100 percent of U.S. GDP. If Congress does nothing this will rise to $20 trillion in three years. The sequestration cuts that did not materialize in the bill wouldn't have made much of a dent in spending. While markets jumped 2.4 percent on the news of the deal's passage, some analysts caution, this rally more likely reflects a general sense of relief that any deal was reached at all. 

Now consider the U.S. has been running trillion dollar deficits since the 2007 recession. As this chart produced by my colleague Veronique de Rugy shows, there's an alarming gap between revenues and spending. In sum, without tackling the long-run trend in entitlements and fundamental tax reform the fiscal future of the U.S. is a bleak picture of higher interest rates, diminished entitlements, and sluggish growth. For a tour of the U.S. in 2042 with the Ghost of the Fiscal Future, check out Matt Mitchell's excellent analysis, here.

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