Why the GOP shouldn’t go wobbly on taxes

June 27, 2011

It’s up to House Speaker John Boehner now. Democrats, the media and Wall Street will be pounding him to agree to raise taxes as part of a debt ceiling deal. But now is no time for Republicans to go wobbly. Here’s why the GOP should stick to its guns until Aug. 2 – and beyond if necessary:

1. The last thing the economy needs is a tax hike. If the economy was too weak to absorb a tax hike last December – when the White House and Congress agreed to extend all the Bush tax cuts for two more years –  its health is even worse today. The economy grew at just a 1.9 percent pace in the first quarter, and many economists now think it might grow just 2.0 percent in the second quarter – or even less. This should be a red flag to Washington. New research from the Federal Reserve finds that that since 1947, when two-quarter annualized real GDP growth falls below 2 percent, recession follows within a year 48 percent of the time. (And when year-over-year real GDP growth falls below 2 percent, recession follows within a year 70 percent of the time.)

 

In other words, the economic recovery is sputtering with stall speed fast approaching. Now would be a terrible time to penalize investors and business, both big and small, with new taxes.

2. Tax revenue isn’t the problem. Spending is. The recent Congressional Budget Office budget outlook was illustrative. The CBO forecast to note is its “alternative fiscal scenario” which “incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period.”

By 2021, the the CBO says, the annual budget deficit would be 7.5 percent of GDP and by 2035 a truly monstrous 15.5 percent. Throughout this period, tax revenue would be 18.4 percent, right around the historical average. But spending would be 25.9 percent in 2021, 33.9 percent in 2035 vs. an average of roughly 21 percent. It’s spending that’s way out of whack, not revenue.

But let’s say all the Bush tax cuts were left to expire, as was AMT relief. Assuming no economic fallout, according to the CBO, revenue would be 23.2 percent of GDP by 2035. Three problems here: a) even with all those tax increases, the annual budget deficit would still be nearly an unsustainable 10.7 percent of GDP in 2035; b)  the U.S. tax code has never generated that level of revenue and almost certainly can’t without a value-added tax; and c) there would be tremendous economic fallout. Axing all the Bush tax cuts would chop three percentage points off GDP growth, according to Goldman Sachs, certainly sending America back into recession. Tax revenue would again plummet.

And as bad as those numbers are, they don’t fully take into account the economic impact of all that debt. When the CBO does makes those calculations, total debt as a share of output is not 187 percent of GDP – the number you frequently see in media accounts – but rather 250 percent of GDP since economic growth would slow sharply due to debt overload. And more than likely the economy would suffer a debt crisis long before 2035 came around.

3. The key to boosting tax revenue is faster economic growth. A team of economists from the American Enterprise Institute recently fashioned a debt-reduction plan that would raise tax revenue to a long-term level of 19.9 percent of GDP. That’s pretty high when you consider there have only been three years in U.S. history that have seen a higher tax burden. Its tax plan:

To achieve this goal, the income tax system would be replaced by a progressive consumption tax, in the form of a Bradford X tax. To address environmental externalities in a more cost‐effective and market‐based manner, energy subsidies, tax credits, and regulations would be replaced by a carbon tax.

But the AEI team also notes that such a tax plan would more than likely boost growth:

Economic simulations have repeatedly indicated that replacing the income tax system with a consumption tax can boost economic growth, although the magnitude of the gains depends on the assumptions that are made and on the detailed provisions of the consumption tax. One widely cited study estimates a 6.4 percent gain in long‐run output from the adoption of an X tax.

Our plan also reduces transfer payments to the elderly, which should further increase private saving and long‐run growth. These growth effects have not been taken into account in the estimation of our plan. Accounting for them suggests that actual revenue requirements are lower than those stated above. For example, if our plan increases long‐run output by even 5 percent and if government spending does not increase in response to the expansion of output, then the actual long‐run revenue requirement will be 19.0, rather than 19.9, percent of GDP.

Revenue of 19.0 percent of GDP happens to be the same revenue requirement of Rep. Paul Ryan’s Path to Prosperity debt-reduction plan. And tax reform isn’t the only thing that can boost economic growth. Increasing high-skill immigration, implementing regulatory reform, and raisng productivity in education, government and healthcare could pump up economy-wide  GDP growth by at least a full percentage point, according to McKinsey Global Insitute.

Bottom line: Higher taxes would hurt the economy, wouldn’t solve the debt problem and aren’t really needed anyway.

 

23 comments

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Maybe my math is a little iffy, but US govt revenues are $2.2T is fiscal 2011 and the US economy (by GDP) is $15.4T, ie US govt revenue now is 14.3% of GDP. So you advocate for 19.0% (or $2.93T) as per the Ryan plan but somehow figure that tax increases are NOT the way to go… as per your own suggestions America is short $730B on the revenue side of things. Well when conservatives can explain the voodoo of increasing govt revenues by *4.7% of GDP* without tax increases then I’ll stop calling every conservative pundit that advances the notion a raving loon. By the by, cutting loopholes = tax increase and there aren’t even close to $730B in tax code anyway. Can the euphemisms and let’s get serious here – nobody wants monster deficits.

Posted by CDN_Rebel | Report as abusive

[...] The Reuters blogger cites three reasons: [...]

I agree completely that we need to amend, rework, etc, the current system of income taxation, but replacing it with a consumption tax? An inherently more regressive tax system, that by definition favors the affluent, at a time when people are still trying to get back on their feet?

Only a complete AEI/Cato shill like yourself would put that in print. Check, please.

Posted by Adam_S | Report as abusive

The economy is sputtering because the lowest end of the income scale doesn’t have money, doesn’t have jobs, and doesn’t have savings.
The taxes being talked about raising aren’t going to affect those people…they are going to affect the people at the higher end of the scale, who can actually afford those taxes, because they already control most of the free wealth of the country, and whose lives have gone on almost untouched by ‘hard times.’
I’m sorry, this article misfires on almost points.

==RED

Posted by REDruin | Report as abusive

Increasing high-skill immigration? That’s a joke on all Americans. I work with many “high-skill immigrants” They are no better than our home grown high skill. They are just cheaper, much cheaper. I know plenty of I.T.ers that are out of work, ready to return, but noooooo. For companies, the bottom line is the new patriotism. Stop the immigration and hire our own, we have enough of them going hungry. If my own family were in the same dire straits as America, I surely would not invite strangers into my home to share a piece of my ever dwindling pie.

Posted by jkelley76 | Report as abusive

he economic recovery is sputtering with stall speed fast approaching..http://www.sunsetperulimite d.com

Posted by cuscoperu33 | Report as abusive

James you are another spinning republican. Tax increases are going to be aimed at the wealthy, who have already benefited through the last two decades, even during the great recession.

Posted by Kdoggie | Report as abusive

After tax cuts in 2001, in 2002, in 2003, in 2004, 2005, 2006, 2008, 2009, 2010, unemployment is higher than after Reagan hiked taxes in October 1982, January 1983, April 1983.

Yeh, I know, in 1983, interest rates were falling as the Fed eased up on money supply, to 5-6%! The marginal income tax rate was 50%. But Reagan doubled the gas tax when gas prices were close to record highs, and 18MPG was a high mileage car. And unions were still a major force in driving up wages, though they were under attack from conservatives because workers were earning too much relative to management who only earned about 18 times as much. And while Reagan was attacking regulations, they were far greater than today, greater than anything Obama has proposed. Yet with all those heavy burdens on the economy: the unions, the regulations, the high gas prices, the extremely high interest rates, the high taxes, the economy switched into growth mode creating almost as many jobs as Carter created in his failed term without job creation, but while Reagan didn’t create 10 million jobs like Carter, Reagan did create 7 million jobs in 4 years while Bush and his tax cuts after tax cuts after tax cuts, created no jobs in eight years.

The economic theory that tax cuts creates jobs is as valid as flapping your winds like a bird will let you defy gravity and fly.

Posted by mulp | Report as abusive

Mr. President , I am sure that you are aware of how badly our country is being desimated by political greed and ignorance and a general disregard for America and Americans. So here is my offer, I will rebuild the country and put every one to work again if there is a promise to clean up the criminals.

snet by, Adnan Sakli
Title holder of the Federal Reserve System of Banking.
The only person that giives a Damn about America and what happens to the Americans.
If you are real , I will expect your reply, If not, you are just the same as the rest.
I have the funds to restructure the national debt. and kick start the economy with jobs and industry.
I am ready to place 20 Trillion Dollars of legal money to place into the structures of America. It is waiting to be used for America and Americans.

Posted by Mr.Sakli | Report as abusive

Shame on Reuters for publishing more ultra-conservative drivel without a balancing article about the root cause of our unemployment and fiscal problems, namely the channeling of wealth from the middle class to the ultra rich.

Posted by moderate_ | Report as abusive

“The last thing the economy needs is a tax hike”

Does the author understand that this is Keynesian economics? And that the corollary to this statement is that the other thing a struggling economy does not need is spending cuts?

Yes, we need continued fiscal stimulus until more of the 8.8 million private sector jobs lost between 2/08 – 2/10 are recovered. Just like we had under President Reagan in the early 1980′s when we not only had tax cuts but also post WW II records for spending as a % of GDP in FY’s 1981, 1982 and 1983. We did not stop our record spending until ALL of the 2.7 million jobs lost in the 1981-82 recession had been recovered. In practice President Reagan was a Keynesian. Just like Mr. Pethokoukis with his first bullet point.

Note that the Keynesian approach worked in the early 1980′s. We should give it a chance to work today.

Posted by stichmo | Report as abusive

Cutting tax subsidies for oil companies making tens of billions in pure profit per quarter is not a tax hike.

Reducing the Bush tax break for multimillionaires, which is currently contributing 30% of the Federal Budget deficit is necessary and many people in this tax bracket are willing to see their tax rates raised.

Tax cuts for the rich have not created jobs in the US, and while taxes were generally higher during the Clinton administration the economy performed better than it did during the Bush administration when taxes on the wealthy were reduced in rate.

The entire GOP argument is bogus, and erroneous.

Posted by leschwartz | Report as abusive

Raising taxes on the wealthy will have 4 impacts:

1. The truly wealthy will move their dollars from investments to tax-free muni bonds. They will count the tax savings as part of the ROI.

2. This investment shift decreases the dollars available for businesses, creating a further drag on expansion.

3. The dollars that come out of small business are largely a reduction in working capital where every dollar represents 28 dollars in economic activity annually. (Product with a 4 multiplier and 7 inventory turns.) Those small businesses will need to cut staff to stay in business – and since they have already done this, many will simply shut their doors.

4. The small increase in revenue government does receive will be spent on projects where there is NO ROI (SEE Minneapolis light rail or Obama’s high speed rail ROI) or on projects where the ROI is so long that you will not get the stimulus impact needed for our crippled economy.

This Keynesian approach makes as much sense as returning to the ancient medical practice of “bleeding” a patient so they will get better.

Posted by sclemens | Report as abusive

[...] The last thing Americans need is a tax hike [...]

[...] Don’t go wobbly, GOP Written by admin on June 28, 2011 — 2170Leave a Commenthttp%3A%2F%2Fjennerationx.com%2F2 011%2F06%2Fdont-go-wobbly-gop%2FDon%27t+ go+wobbly%2C+GOP2011-06-28+14%3A24%3A03a dminhttp%3A%2F%2Fjennerationx.com%2F2011 %2F06%2Fdont-go-wobbly-gop%2F http://blogs.reuters.com/james-pethokouk is/2011/06/27/why-the-… [...]

[...] same time, Wall Street and the Federal Reserve continue to downgrade their economic expectations.  As I wrote yesteday: The economy grew at just a 1.9 percent pace in the first quarter, and many economists now think it [...]

The 9:32 comment by sclemens is silly. Interest rates are at record lows which is what truly matters for business investments. The fact is that government needs to pick up the slack right now in spending, just like Reagan did in early 1980s.

ROI on government spending is about keeping people employed and in the work force, rather than on the dole.

What do you think the ROI has been on the $1 trillion spent fighting in Iraq and Afghanistan?

Posted by Kdoggie | Report as abusive

CDN_rebel, the reason is this: when you raise tax RATES, you usually reduce tax REVENUE. Business and individuals try to reduce their tax burden by shifting resources from growth-producing endeavors to value-preserving endeavors. This actually reduces the amount of dollars the gov’t takes in. When you reduce tax RATES, the opposite happens; REVENUES go up because money shifts into (low-tax) growth-producing efforts. This produces more jobs, higher GDP. JFK, Ronald Reagan, and GWB43 all proved what I just said. What I just explained is further illustrated here: http://www.deptofnumbers.com/blog/2010/0 8/tax-revenue-as-a-fraction-of-gdp/

What you can easily see is that tax REVENUES against GDP are remarkably consistent; which means if you want to increase revenue, you have to increase GDP, which means you have to create growth. Tax RATE increases don’t do this, they do the opposite.

Whenever someone says they want “tax increases,” immediately ask them to clarify whether they talking about tax RATE increases, which only serve class warfare, social engineering, and self-congratulatory purposes, or are they talking about tax REVENUE increases, which actually benefit our financial situation.

Posted by Jude_in_Tampa | Report as abusive

[...] Pethokoukis provides the reasons.  As you’ll note, economically, they’re not rocket science, but they certainly are [...]

Please note that my book Keynes Hayek: The Clash That Shaped Modern Economics is published by W.W.Norton in October.
Professor John B.Taylor of Stanford and the Hoover Institution says that: “Nicholas Wapshott brings the Keynes-Hayek fight of the 20th century back to life, making the clash both entertaining and highly relevant for understanding economic crises of the 21st century.”
Read an extract at: sites.google.com/site/wapshottkeyneshaye k/
Nicholas Wapshott

Posted by wapshott | Report as abusive

Please note that my book Keynes Hayek: The Clash That Shaped Modern Economics is published by W.W.Norton in October.
Professor John B.Taylor of Stanford and the Hoover Institution says that: “Nicholas Wapshott brings the Keynes-Hayek fight of the 20th century back to life, making the clash both entertaining and highly relevant for understanding economic crises of the 21st century.”
Read an extract at: sites.google.com/site/wapshottkeyneshaye k/
Nicholas Wapshott

Posted by wapshott | Report as abusive

11:35 is ignorant. Reagan got the economy out of a steep recession by slashing all marginal tax rates and deregulating the government. And guess what? Revenues doubled in 8 years. Yes, spending increased too, but as a percentage of GDP, is remained around 21%. We need to slash rates and reduce spending to generate more revenue and cut our dept.

Raising taxes doesn’t increase revenue. You assume people will work as hard to take home less. Clinton raised personal income taxes but reduced capital gains taxes to spur growth. But in the end, it still resulted in a recession…until W cut taxes and the economy grew again.

Obama is doing the opposite of Reagan. He’s increasing spending while revenue decreases. Thinking he’s helping the economy by creating government jobs and tax payer funded jobs is ridiculous. It’s like needing extra family income, so you decide to pay your kids to wash the car or do chores around the house. They may have extra money temporarily, but you have less and eventually you won’t be able to keep paying them.

Posted by Teleprompt2012 | Report as abusive

You Liberals, Democrats and Socialists are absolute fools. Your whole doctrine is based on one thing and one thing alone…….POWER.Enslave the population and make them dependent on Government so you can get re-elected.

We have an idiot for a president who doesn’t have the first clue about the engine of our economy……the private sector and in particular small business. If you increase Government Spending, you crowd out the private sector investment Then you throw in a ton of regulations in the form of the EPA, NRLB, Obama-crap-care and the energy department and what do you have……a stalled economy and high unemployment with no end in sight( well at least between now and 2012). It really blows my mind how democrats can say with a straight face that taxing the rich more will help ease our financial mess…..they already pay the vast majority of the tax bill. As the Author correctly stated, raising taxes with collapse this economy.

I actually think the possible collapse of Greece will be a good thing for this country because it will finally wake us up to the impending disaster coming our way if we allow Barry and his cohorts to continue to occupy the White House. Can’t any of you Kool-aid Libs see that will we be in huge trouble when Interest rates rise as they will have to do in order to not only control the Fed-induce inflation that is on the way but also to attract the buyers for our bonds……if we don’t slash spending now and reform entitlements…….of course you libs don’t care, you have a president who is a scholar of the teachings of Alinsky.

Posted by leedspaddy | Report as abusive

3:26 in partially correct. Reagan did cut taxes when economy was in recession but then raised them when economy improved. See http://www.ritholtz.com/blog/2010/07/rea gans-tax-increases/ for summary. Reagan was wise enough to know that revenues need to increase during times of prosperity. W. did the opposite, starting two unfunded wars, expanding medicare w/out the revenues and cutting taxes.

Government spending does not equal government jobs. This is a typical right-wing spin statement. Most of the deficit spending has been about getting money back to people so they spend it and create jobs.

Posted by Kdoggie | Report as abusive

It’s nice to see the posters, in general, understand the issues better than the “journalist”:

1) There *is* a time for supply-side stimulus – but that’s when demand exceeds supply and we face inflation. We face the opposite situation where supply already exceeds demand. Ask any businessman whose warehouse is full of stuff he can’t sell and he’ll tell you what he needs is more customers, not more employees producing more goods he can’t sell. Now, I know that if every businessman suddenly and all together ran out and hired new employees, those employees would have more money and they’d buy more stuff. The problem is that what works for the whole, doesn’t work for the individual businessman, since to make a profit, he relies on someone else to increase the number of their employees, while he constrains the number of his.

2) Lumping all tax increases together is insane and best, duplicitous when I’m being polite and complete manure when I’m being blunt. The situation matters, but so does who receives the cut. We’re in a demand-induced, so to increase demand, we need to get more money in the hands of the folks with the greatest need. Give a dollar to someone whose belly is growling from hunger and that person isn’t going to salt the dollar away in an offshore mutual fund; that person is going to spend the money on food. It doesn’t matter what percentage of any tax reduction the wealthy salt away rather than consume, the fact is that any percentage is a higher percentage of money that isn’t going to stimulating demand.

3) If we have a demand slump, and the wealthy can’t any reason to invest in new production capacity when the existing capacity is sitting idle (the wealthy didn’t get wealthy by being fools)someone has to buy stuff. People (outside of the wealthy) don’t have the money when they can’t pay their mortgages because they’re now unemployed. States can’t spend the money because they are constrained by not spending more than they take in. Guess who that leaves – the federal government. At this point, only the federal government can stimulate demand and it can do it in two ways: a) spending money itself (on infrastructure improvements and R&D that has a prospect of long term payouts and keeping US in the lead on new technologies in fields that are too risky for private companies) and by funneling the money to those who *will* spend it – e.g., the unemployed.

And this is where the the difference in tax increases comes in. Taxing those who will not spend everything they make in the US economy and redistributing that money to those who will spend it all in the US economy isn’t rocket science. When it comes to engineering a recovery, it’s just common sense. Whether one is morally aghast at the idea of income redistribution or not, to argue that it makes no economic sense is pure manure.

Posted by MVR | Report as abusive

This article is vanilla Conservative talking points and obviously the same for the Conservative followups…the entire thesis is based on conservative think tanks. The facts are totally misrepresented. Corporations and the Wealthy are sitting on monstruous piles of cash they could invest if DEMAND was there. The Republican thesis that Tax Cuts resolves growth is false…We have a Revenue problem and we cannot fix the Debt accumulation due to Reagan and Republican policies be fixed on those who have less…We have to finally recognize that Capitalism is not perfect and that Gangster Capitalism is worse! the latest is what conservatives are doing transforming this country into an Oligarchy under control of the Rich. This has to stop

Posted by mahilena | Report as abusive

“Inflation is not caused by the actions of private citizens, but by the government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bankrobbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments.”– Ayn Rand

Posted by cwgf | Report as abusive

[...] Why the GOP Shouldn’t Go Wobbly on Taxes - Reuters [...]

[...] James Pethokoukis: If the economy was too weak to absorb a tax hike last December – when the White House and Congress agreed to extend all the Bush tax cuts for two more years – its health is even worse today. The economy grew at just a 1.9 percent pace in the first quarter, and many economists now think it might grow just 2.0 percent in the second quarter – or even less. This should be a red flag to Washington. New research from the Federal Reserve finds that that since 1947, when two-quarter annualized real GDP growth falls below 2 percent, recession follows within a year 48 percent of the time. (And when year-over-year real GDP growth falls below 2 percent, recession follows within a year 70 percent of the time.) [...]

[...] mammouth failure of a 2012 budget.  Plus, would tax hikes really right the ship?  Over to you, Jim Pethokoukis (once [...]

[...] 2) The president perpetuated this myth: “You can’t reduce the deficit to the levels that it needs to be reduced without having some revenue in the mix. “ Yet Rep. Paul Ryan’ s Path to Prosperity does just that, even while assuming — to satisfy the Congressional Budget Office — the economy grows at a snail-like 2 percent pace year after year for decades. If we need more money, grow the economy faster. [...]

[...] James Pethokoukis | Analysis & Opinion | Reuters.com. AKPC_IDS += "3939,"; [...]

[...] Pethokoukis from Reuters has written a powerful article detailing why we should not raise taxes: It’s up to House Speaker John Boehner now. Democrats, [...]

“1. The last thing the economy needs is a tax hike.”

Au Contraire.

Raising taxes on the Rich & Corporate worked like a charm for both Presidents FDR and WJC. It all depends what you do with the money.

The periods of greatest economic prosperity in this country occurred when the top federal personal income tax BRACKETS were at 81%, 85%, and even 91%, while the top corporate federal income tax BRACKET was at 50%, AND after the top federal income tax brackets were raised on the Rich & Corporate.

~

“2. Tax revenue isn’t the problem. Spending is.”

Wrong.

According to the independent non-partisan Congressional Budget Office, the vast overwhelming majority of our current federal deficits and debt, as well as our medium-term projected future federal deficits and debt, are from the massive drop in federal income tax revenue as a direct result of the numerous rounds of massive tax cuts for the Rich & Corporate enacted during the previous administration.

Not even close.

Posted by JoeFriday | Report as abusive

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says the G.O.P. should not go wobbly on taxes: “Axing all the Bush tax cuts would chop three percentage points off gross domestic [...]

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says the G.O.P. should not go wobbly on taxes: “Axing all the Bush tax cuts would chop three percentage points off gross domestic [...]

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says a G.O.P. should not go wobbly on taxes: “Axing all a Bush taxation cuts would clout 3 commission points off sum domestic [...]

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says the G.O.P. should not go wobbly on taxes: “Axing all the Bush tax cuts would chop three percentage points off gross domestic [...]

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says the G.O.P. should not go wobbly on taxes: “Axing all the Bush tax cuts would chop three percentage points off gross domestic [...]

[...] Bottom line: But the basic problem here is that Romer, like the rest of Obama’s all-star team, is worried about stimulating consumer demand rather than encouraging — by the removal of tax and regulatory barriers – established businesses and new entrepreneurs to invest, expand, hire and create. And talk of raising taxes distracts from the real work that needs to be done to reduce spending. Whenever economists talk about the need to raises taxes, they are actually making a political argument rather than an economic one.  Either they are ideologically opposed to smaller government or they don’t believe Washington will ever cut spending. But that isn’t surprising since there really isn’t a valid economic argument to support the long-term Obama spending binge. [...]

[...] mammouth failure of a 2012 budget.  Plus, would tax hikes really right the ship?  Over to you, Jim Pethokoukis (once [...]

[...] a debt deal that has big spending cuts but no tax increases? (Besides, of course, the fact that spending is the problem and the last thing this weak economy needs is a tax hike?) Maybe it’s because the last time [...]

[...] Obama. The Treasury secretary considers leaving. James Pethokoukis says the G.O.P. should not go wobbly on taxes: “Axing all the Bush tax cuts would chop three percentage points off gross domestic [...]