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.