Debt / Economy / Fiscal Cliff / Tax

Why do Democrats Want to Raise Taxes?

Last Thursday, Treasury Secretary Tim Geithner presented Congress with the Obama administration’s plan intended to avert the impending fiscal cliff. The plan was, quite literally, laughable. It called for $50 Billion in new stimulus spending, the end of Congressional authority to raise the debt limit, $1.6 Trillion in new revenues from higher taxes on the rich and a promise to try and find $400 Billion in Medicare savings at some, unspecified time in the future. Even the most hardened ideologue cannot possibly believe in the success of a “tax now, cut later” approach to deficit reduction – not based on the government’s recent track record, at least.

The Geithner proposal was obviously a Democratic wish list more than a serious offer. It captures a snapshot of what federal policy would look like if the White House were given fiat power and did not have to worry about that pesky Republican Congress. But why, exactly, does President Obama desire this policy prescription? Particularly, why do Democrats want tax hikes on the wealthy? It is, of course, part of the Democratic dogma and it is a very popular position in the polls, but from a policy perspective, it is unclear what motivates the president’s desire for higher taxes.

For the sake of argument, let us assume the liberal answer to a couple highly debatable questions. First, let’s pretend that increasing taxes always increases revenues. While this is the standard thinking in Washington, it is arguable that tax rates and revenue are, essentially, uncorrelated and that tax policy should focuses solely on maximizing economic growth (check out this graph).

Second, let’s assume that increasing taxes on the wealthy does not hurt economic growth. This actually goes against conventional economic thinking – the Congressional Budget Office says that maintaining all of the Bush tax cuts would increase economic growth by 1.5 percent, but maintaining them for only those making under $250,000 would increase economic growth by 1.25 percent. In other words, raising taxes on the rich means a quarter of a percent loss in GDP growth next year – and that is a bit less than half of the tax increase that the president requested. No matter your political stripes, you shouldn’t want to shrink the size of the economic pie. But again, let’s take the liberal position that tax increases do not hurt the economy.

So why do Democrats want to raise taxes on the wealthy? Some argue the government can take the increased tax revenue, spend more and generate economic growth; others argue that the government can use the revenue to pay down the debt. These goals are, obviously, in direct contradiction. But based on the other policy prescriptions of the White House, neither goal seems to be the motivation for these particular tax increases.

Raising taxes as a way to pay for more stimulus assumes that current deficits don’t matter; this is the position of several high-profile liberal elite – that Washington is unnecessarily obsessed with debts. But if we have learned anything over the past four years, it is that spending increases don’t require tax increases. In fact, with the current Republicans reluctance to increases any taxes (something I argue against here), it would probably be easier for the President to get pure spending (either on infrastructure, other tax cuts for the middle class or an extension of the payroll tax cut) than to advocate for spending and tax hikes. Plus, the President is not calling for that increased spending – he is, at the most, advocating for the maintenance of the status quo on spending. If that is his goal, there is no reason to increase taxes –

Unless you care about the debt.

Decreasing the deficit seems to be the nominal reason for the President’s tax hike plan. Implicit in this belief, however, is that deficits matter and ours is too big. And if this is the mainstream Democratic belief (and let’s hope that it is) than the tax increases are insufficient to tackle the impending crisis and the President seems unwilling to manage the actual drivers of the debt. As President Obama likes to say, it’s math.  The elimination of the top rate Bush tax cuts would pay for less than a week worth of government spending this year. You just cannot tax the rich enough to solve the debt crisis.

To just stabilize the nation’s debt, four trillion dollars in cuts and hikes are needed, at minimum; even if you accept the President’s $1.6 trillion in new taxes, you either need $2.4 Trillion in spending cuts (mainly to Medicare) or you need even more tax hikes (probably on the middle class). This is a far cry from the current strategy of “let’s discuss $400 Billion in the future.”

So if the revenue is insufficient to solve the debt problem and the President’s plan does not call for more stimulus spending, then why call for the tax increases? Fairness. This trope was reiterated time and again during the campaign. The rich need to pay their “fair share.” We need “shared sacrifice” to put America back on the right track. America’s tax system is not progressive enough, the left argues – the rich just don’t pay a large enough portion of the government bill.

But here is the shocker. America, already, has the most progressive tax system in the developed world; if one argues that the rich are not paying enough in the U.S., one has to argue that there is no country that has high enough taxes on the wealthy. The top ten percent of income earners in the U.S. paid 45.1% of all taxes, not just income taxes, in 2008 – the highest of any developed nation.

But, Democrats argue, “the rich make far more money; they should pay a far larger percentage in taxes.” it is true, of course, that the rich are richer; the top decile of earners made 33.5% of all income. But one can take this income inequality into consideration. By looking at a ratio of taxes paid to income earned, we can measure progressiveness independently of income inequality. Below is that ratio for all developed countries, courtesy of the OECD – the international body that initially published this finding.

Progressivity Graph 3

The U.S. has the highest ratio of taxes paid to income earned by our richest citizens. Higher than socialist France or economically disastrous Greece, higher than Spain with its 25% unemployment rate and Sweden with its cradle-to-grave government support.

If you find this analysis of the top 10% unconvincing, The OECD also used a more complicated measure to analyze the taxes paid and income inequality in each country, but the results were the same. The U.S.tax system, quite simply, is the most progressive in the world. A “fair share” argument cannot hold water when faced with these data. Accounting for American levels of income disparity, the rich in this country still pay the world’s largest tax burden.

So if deficits matter, these taxes don’t fix the problem, and the wealthy already pay their fair share, why do Democrats want to raise taxes?

Be sure to let me know, if you find out.

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