Taxes and Deficits

I think I’m starting to make a bit of progress in my effort to get taxes back on the table as part of the solution to our fiscal problem. Instead of rejecting any tax increase out of hand and demanding that all of the fiscal adjustment take place on the spending side, some commentators are now conceding that taxes must rise. The question is how much, in what way, and in return for how much in terms of spending cuts. Here, here and here are my recent columns on this topic, and here, here, here and here are some commentaries.

Let me add a few more points to those I have made already. First, I don’t think we should raise taxes now. Obviously, we need to wait until we are past the current crisis. But I think the debate and preparation need to start now because the time when we will have to deal with the budget gets closer by the day as the baby boom generation gets older and qualifies for Social Security and Medicare.

Forecasters are also starting to wave the red flag of inflation, which will require fiscal discipline as well as tight money. While deficits aren’t per se inflationary, they do make it harder for the Fed to tighten monetary policy. Deficit reduction can also mitigate the high interest rates that necessarily result from Fed tightening. And the time to start worrying about inflation is before it gets going and becomes embedded in peoples’ expectations, labor contracts and other institutional arrangements that tend to perpetuate inflation once established and increase the cost of disinflation.

Furthermore, when the action-forcing event finally arrives that forces fiscal retrenchment it may do so suddenly and without warning. If Congress undertakes a big tax increase under those circumstances, it is likely to do a poor job. It would be much better for some advance thought to be given to how best to raise taxes for a given revenue target. I continue to believe the fiscal hole is so large that only a value-added tax can raise enough revenue without imposing unacceptably large economic costs, a view that others are coming around to as well (see here, here, here, here and here).

Second, I certainly don’t believe that our fiscal problems can be dealt with solely by raising taxes. That would require confiscatory tax rates not just on the wealthy but on much of the middle class as well. I showed the unsustainability of long term budget trends here.

I just think that it is totally unrealistic to believe that holding the line on taxes will somehow starve the beast and force sufficient spending cuts. I made the case against this idea in more detail here. It’s also absurdly naïve to think that even if Republicans regain control of Congress that they can slash spending on their own, as some Republicans seem to believe. Barack Obama is still going to be president until at least 2012 and probably until 2016, and as Bill Clinton proved in 1995 presidential opposition to cuts in entitlement programs is insurmountable because it’s not just a matter of appropriating less money; the law must be changed. And Republican control of Congress also proved that Republicans are just as addicted to pork barrel spending as Democrats, if not more.

Even if Republicans manage to get back the White House and control Congress as well, that won’t be until 2013 at the earliest and they aren’t going to implement massive budget restructuring by themselves; they will need some Democratic support. The proof is that Democrats don’t appear to be able to do health reform by themselves and continually reach out to Republicans despite being rebuffed. Cutting the budget will be a lot harder to do than expanding health insurance coverage because the latter has winners and losers but the former has only losers.

Third, the point I was trying to make in my last column was more about reestablishing a budget rule that included taxes as a price for higher spending than about raising taxes whenever there is a deficit. Such a rule would have precluded many of the deficit-raising actions of both parties in recent years. I responded this way in a comment on Diane Rogers’ site:

Some of the commentators miss my point. What I am talking about is reestablishing a rule that new programs be financed. We had such a rule from 1990 to 2002 called PAYGO, but Republicans abandoned it because the rule made it impossible to cut taxes without raising taxes or cutting spending. They rationalized this rule change on the grounds that deficits don’t matter.

In the short run Republicans got the tax cuts they wanted. But by destroying fiscal discipline in the process they opened the door to Democrats spending. Imagine how different the debate over stimulus spending would have been in February if PAYGO rules were still in effect?

Therefore, I continue to believe that primary–not exclusive, but primary–responsibility for our current budget mess belongs to Republicans.

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