The New York Times – February 24, 2009
Toward the end of Monday’s meetings on fiscal responsibility at the White House, Senator Kent Conrad stood up and produced a little bolt of honesty. “Revenue is the thing almost nobody wants to talk about,” said Mr. Conrad, the chairman of the Senate Budget Committee. “But I think if we’re going to be honest with each other, we’ve got to recognize that is part of a solution as well.”
Mr. Conrad’s frankness was delivered in the cryptic language of budget experts, and many people might have missed the point. So allow me to translate:
Your taxes are going up.
They will probably go up in the coming decade, and the increase will be permanent. For a half-century, federal taxes have remained fairly constant relative to the size of the American economy — equal to about 18 percent of gross domestic product. But the 18 percent era has to end soon.
It won’t end because President Obama is some radical tax and spender, either. It will end because of a basic economic reality.
Americans have made it clear that they want a certain kind of government, one that can field a strong military and also maintain popular programs like Medicare. Yet we are not paying nearly enough taxes to maintain those programs. Even major changes to the health care system — the single most important step for closing the budget gap — will not close it entirely. Taxes must rise, too.
This is a point on which serious Democrats and serious Republicans agree, even if they do so with euphemism. “We are on an unsustainable path,” says Peter Orszag, Mr. Obama’s budget director. Judd Gregg, the ranking Republican on the Senate Budget Committee, has said, “Revenues are going to have to go up.” Douglas Holtz-Eakin and Dan Crippen, budget experts who advised the McCain campaign, have quietly acknowledged the same.
Fortunately, the coming tax increase does not have to be economically ruinous. Despite all the scary stories you’ve heard, the evidence that higher taxes necessarily cripple an economy is somewhere between thin and nonexistent.
When over the past 60 years did the American economy grow fastest? The 1950s and 1960s, when the top marginal tax rate was a now-unthinkable 90 percent. And when over the past generation did the economy grow fastest? The late 1990s, when President Bill Clinton briefly took federal taxes to 20 percent of the G.D.P.
The real uncertainty is how, in the current political climate, Mr. Obama will manage to persuade people that taxes must go up. In his speech on Tuesday night, he didn’t even try. But he doesn’t have forever to do so.
Eventually, the foreign investors lending the federal government billions of dollars every week — to make up for the current gap between taxes and spending — will need a reason to believe that those loans will be repaid. Otherwise, they will begin demanding much higher interest rates. That could create a new financial crisis.
“Something that’s unsustainable, like a dysfunctional relationship, can go on longer than you expect,” Mr. Orszag has said, “and then end faster and messier than you think.”
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In his new book, “The Tyranny of Dead Ideas,” Matt Miller nicely lays out the history of American taxes. He begins the story with Adolf Wagner, a 19th-century German economist who predicted that taxes would rise as societies became wealthier. The idea became known as Wagner’s Law.
“As people grew more affluent,” writes Mr. Miller, a journalist and a consultant for McKinsey & Company, “they’d want more of what only government could provide — a strong military, public order, good schools and assorted welfare benefits, services that private citizens would have trouble arranging for on their own.”
The tax increases to pay for these activities do bring a cost: they reduce people’s incentive to work. But history has shown that this cost isn’t enormous. Taxes rose sharply in the first half of the 20th century, starting from just a few percentage points of the G.D.P., and the country still prospered. So long as the government spends the money well, the benefits from taxes — security, education, health — can far outweigh the costs.
To be sure, the federal government is not currently spending its tax revenue very well. In particular, it’s wasting billions of dollars each year on health care that doesn’t make people healthier. Unless Medicare’s policies are changed, this waste will lead government spending to rise to 32 percent of the G.D.P. over the next three decades, from 20 percent in recent years.
But an overhaul of the health care system won’t be enough to bring that number down to the current level of taxes. That’s the whole point of Wagner’s Law. Over time, societies will spend more of their resources on services like medical care, since they can already afford basic material comforts. And these services are precisely the sort of service that fall to the government.
Think of it this way: A tax increase isn’t so much a barrier to a society becoming richer as it is a result of a society becoming richer.
To the extent that Mr. Obama has talked about raising taxes, he has focused on households that make at least $250,000 a year. And their taxes will certainly need to go up. In the last three decades, as the pretax income of the top 1 percent of earners has soared, their total federal tax rate has fallen to 31 percent, from 37 percent, according to the Congressional Budget Office.
But the problem can’t be solved just by taxing the rich. That top 1 percent pays only about one-quarter of federal taxes. Once the recession ends, taxes on the not-so-rich will need to rise, too.
There are many ways this could happen. Congress could pass a consumption tax, which would bring the side benefit of encouraging people to save more. Or it could raise tax rates. Or it could get rid of the various subsidies for housing, which create an incentive to overinvest in housing. (How’s that working out, by the way?)
But none of these ideas would be nearly as painless as the niceties of tax jargon sometimes imply. In the end, the ideas aren’t just about “tax simplification” or a “flatter, fairer system.” They’re about raising taxes.
So how will it happen? The best bet, I think, is a jujitsu strategy: someone will figure out how to convert weakness into strength.
We find ourselves facing long-term budget deficits largely because we don’t pay enough heed to the future. Paying less tax in 2009 is concrete. Leaving our children with a solvent government is less so.
But this same short-sightedness can be turned on itself. In 1981, President Ronald Reagan named Alan Greenspan to head a bipartisan commission charged with closing Social Security’s deficit. At the commission’s recommendation, Congress increased Social Security tax rates and raised the retirement age. The rub was that most of the changes didn’t take effect until future years. The last of them still haven’t taken effect.
Mr. Greenspan’s reputation isn’t what it used to be. But he was onto something here. Increasing tomorrow’s taxes is much easier than increasing today’s.
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