Economy & Budget

Deficits Prompt Revenue Scavenger Hunt

With a $1.4 trillion federal deficit last year, the scavenger hunt for new revenue is on in earnest. Budget pressures will only increase and the people who should be most worried are not the people already paying the most, but those representing new revenues to reap.

The budget situation is projected to go from bad to worse. Last year, the federal government spent one-quarter (24.7%) of everything America produced and the deficit was one-tenth (9.9%) of the nation’s gross domestic product. This year is expected to be very close to the same. These levels have not been reached since World War II’s impact ended.

As bad as the present is, the future offers worse. The Congressional Budget Office’s 2009 long-term forecast estimated federal spending would hit 27.4% of GDP in 2035, 31.7% in 2050, and 43.7% in 2080.

Since Washington won’t cut spending, you can expect rising taxes. The recently enacted healthcare bill provided a hint of the taxing ingenuity that will prevail from now on.

Unprecedentedly, that legislation subjected the unearned income of high earners to payroll taxes. The problem is this new precedent has diminishing returns. Top earners already pay the lion’s share of taxes: the top 3.7% of tax filers pay 37.2% of total federal taxes (income, payroll, and excise). They also have the greatest flexibility in shifting their types of income—tax planning and behavioral changes will certainly divert resources and diminish projected revenues.

To gather the amount of revenue soon to be needed, the taxman will have to find other people to tax than the top earners. But where to find a large source of relatively over-looked income? In the current climate, income will go from being overlooked to looked-over very quickly.

The table below gives a good indication that the taxman will shift his view to gain more revenue.

 

While those making less than $75,000 pay only about one-fifth of total federal taxes, they earn about one-third of the nation’s income. That one-third of the nation’s income will become an increasingly inviting target as spending continues to increasingly outstrip revenues.

How inviting a target is it? If it were taxed at the same ratio (24.2%) as those making above $75,000, it would yield an astounding $371 billion in additional annual revenue.

Of course, critics will observe that America’s tax system applies increasingly higher rates as income increases. Applying the same rate of taxation to those below and above the $75,000 annual threshold would violate that system.

Yet the current tax-to-income ratio for the under-$75,000 population is below the 15.3% payroll tax rate, which all earned income is supposed to pay. Just applying that 15.3% rate—effectively assuming no income tax rate—would still produce an additional $57 billion a year in new taxes. Put in context, that would generate more tax revenue over ten years than all the estimated taxes in the recently passed health care reform bill.

These illustrative points may seem far-fetched, but what really strains credibility is the assumption that America can continue to increase spending without doing something like this. All the current discussion of imposing a value-added-tax is no more than seeking to access this very income, just by other means.

Instead of simply increasing the rates of the current income tax system for those in lower income groups, the VAT would do the same thing through a new system. Granted, the VAT has the economic attraction of taxing consumption, rather than earning and investment. However from a fiscal standpoint, its principle attraction still remains gaining access to more revenues—just by means of a different rationale—from more people.

The overarching point remains overspending. Until that is controlled, no tax system can satisfy it. It is the nature of economics that wants are unlimited, while means are limited. If the former remain unrestrained, then in short order, the latter will be unable to supply them.
What has been bad fiscal policy for the upper-income population, will soon be bad for those making less. It has been the fiction of politics to insist otherwise. And it will be the ultimate irony of ideology, if the left, which has espoused wealth redistribution, were to see redistribution’s supposed beneficiaries consumed in the demand for taxes.

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