Behind the scenes, serious people in the administration and Congress, of both parties, are discussing ways to avert the economic shock of suddenly hiking taxes and throttling back spending. But there can be no pathway to success unless enough partisans on both sides give up on their foundational myths: for Republicans, that the fiscal challenge can be solved through spending cuts alone; for Democrats, that tax increases on the wealthy will suffice.
I’ve spent many words debunking the Republican myth, so this column will concentrate on its Democratic counterpart.
The two myths, it must be said, do not have equally strong holds on their adherents. No new taxes is the Republican creed. Democrats are not quite as dogmatic with no more spending cuts. After all, President Obama and congressional Democrats accepted nearly $1 trillion in cuts as part of the supercommittee deal whose failure is now leading to the cliff.
Even after those painful cuts, Obama stresses the need for a balanced approach, both raising revenue and controlling entitlement spending. The grand bargain he tried to strike with House Speaker John Boehner (R-Ohio) included increasing the age for Medicare eligibility and making Social Security cost-of-living increases less generous.
But in the leftward precincts of the Democratic Party, including among many members of Congress, there is strong resistance to the balance message, and significant attraction to the allure of the argument that the country’s fiscal problems could be solved if only we asked the rich to pay their fair share.
If only. The problem with this argument is that it is untrue. As President Bill Clinton might say, it’s a matter of arithmetic. Raising taxes on the wealthy is necessary but not sufficient to narrow, no less close, the fiscal gap. Indeed, that is the title of a new paper by Third Way, the centrist Democratic group: “Necessary but Not Sufficient: Why Taxing the Wealthy Can’t Fix the Deficit.” The study, by David Brown, Gabe Horwitz and David Kendall, is twinned with one that goes after Republican orthodoxy: “Death by a Thousand Cuts: Why Spending Cuts Alone Won’t Fix the Deficit.”
The “Taxing the Wealthy” paper examines three scenarios of doing just that. Under the first, entirely reasonable scenario, the Bush tax cuts for the wealthy (household income of more than $250,000) would expire, deductions for those with high incomes would be limited, the estate tax broadened, the capital gains tax increased by five percentage points, and the Buffett Rule adopted to ensure that those with incomes exceeding $1 million pay at least 30 percent. Here’s what happens: The national debt doubles as a share of the economy by 2035. The annual deficit in 2040 exceeds $4 trillion, adjusted for inflation.
Under the second, really-soak-the-rich scenario, the government does all of the above — and then piles on enough taxes to exceed the record-high 21 percent level for revenue as a share of the economy. The top rate approaches 50 percent, and the second- and third-highest rates, for income from $217,000 to $388,000, go to 38 percent and 41 percent. The amount of income subject to Social Security taxes rises from $107,000 to $170,000. Even then, the national debt doubles as a share of the economy by 2040. The deficit that year exceeds $3 trillion.
The third, punishing-taxes scenario, shows what it would take to get the debt under control — not balance the budget but limit deficits to 3 percent of gross domestic product — through taxes alone. All of the first-scenario changes would be adopted, along with raising the cap on Social Security. Beginning in 2019, all income tax rates would rise by five percentage points, along with a 10-point hike in capital gains taxes. In 2023, an eventual 10 percent national value-added tax would begin.
Here is the myth-busting bottom line: “Relying on taxes alone to hold long-term deficits at 3 percent of GDP would require phasing in a 60 percent tax increase on the median-income family, raising its annual tax burden by $6,200, in 2012 dollars.”
And that would be Looney Tunes. Meep meep!