Tax Brackets and Balanced Budgets

By John Lumbard.

  Washington has abruptly backed away from a proposal to extend the Bush tax cuts for middle and low-income taxpayers, while bumping the rates for higher-income taxpayers back to the levels of the 1990s.  Both parties were using the debate to score political points—they were trying to box their opponents into positions that would look bad in political advertisements—so inaction was always the most likely outcome.  

Postponement is a good thing, and not just because higher tax rates—even on a small number of our citizens—could hurt the fledgling and sluggish economic recovery.  If that sounds like a baby pigeon with a hangover, we’ll just have to roll with it . . . . .  An even bigger reason to hold off on these tax cuts relates to the Grand Bargain that the President described to George Stephanopoulos in his first weeks in office.

The grand bargaining is already underway, behind closed doors at the National Commission on Fiscal Responsibility.  You can be sure that it involves both spending cuts and tax increases, and that its passage will depend on the perception that every American is sharing the pain.  If we raise taxes now we’ll be forcing a small group of citizens—about 2% of the population, which pays half of the nation’s taxes—to make concessions before the bargaining even gets under way.

Rest assured that the wealthy will eventually pay more.  A couple of years ago I saw the results of a poll saying that most Americans are opposed to taxing more than half of anybody’s income, but the wealthy residents of most states are still under that threshold—even if you include all state and local taxes—in most jurisdictions.  Residents of California will, as always, have to pay extra . . .

The important thing is to recognize that the wealthy are like anybody else;  if they feel that they’ve been singled out as a powerless minority that can be routinely robbed by the gang at the bus stop, they’ll stop taking the bus and stop going to work.  It can happen, and it did happen right here;  in the 1950s our top tax rate was 91%, but we weren’t able to collect as much revenue as we did during the Clinton years.  The same can be said about a long stretch in the 60s and 70s when the top rate was 70%. 

In fact, our federal government has never (apart from 1944, 1945, and 2000, at the peak of the stock-market bubble) been able to collect more than 20% of GDP in taxes, no matter how high the rates were.   If we had smart people in Washington they would figure out how tax rates  correspond to tax revenue, and refrain from pushing those rates so high that we actually collect less revenue.  And if the most we can collect is 20% of GDP, they should choose the lowest tax rates that produce 20% of GDP.  

If we had really smart people in Washington they would recognize this limit for what it is, and mandate that spending never ever grow beyond the most that we can ever possibly collect. 

Well, duh.


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