01 May, 2011

A Taxing Discussion

If you don’t subscribe to Megan McArdle’s posts at the Atlantic, you’re really missing something. She recently made a couple posts on what we’d actually need to do to tax our way out of our debt problems. The articles are well worth a read in their entirety. Go here and here.

Basically, she points out that we’d have to get our tax receipts in the range of 25% GDP, and what that means.

Without arguing about whether our tax system is fair or not, the fact is that the federal income tax is the most variable part of the code, and the federal income tax is now very progressive; it collects most of its revenue from people at the top.  (Whether it should collect even more is an argument for another day.)  Because it collects most of its income from people at the top, and because the incomes of the wealthy are more variable than the incomes of the poor and middle class (Warren Buffett's income can drop by $300,000; mine can't), we're going to get deep troughs in recessions, and high peaks in boom times.  We will get particularly high peaks when the booms are delivering huge chunks of income to a handful of people in a very short timeframe.

In other words, the only times we’ve approached, or even briefly exceeded 20% GDP have been in high economic booms where the rich got really rich. And that’s just to 20%. We need to get t0 25%. So, she assumes a baseline of 18.5%, rather than 20%. Which is still probably high, but we’ll let that go.

A tax hike of 5-6% of GDP doesn't sound like much.  But that's a big tax hike if your baseline is 19%--it means that everyone's taxes go up by about a third.  If the equilibrium tax revenue at Clinton rates is more like 18-18.5% of GDP, then obviously, they have to go up even higher, from a lower baseline. If you try to concentrate the pain on the wealthy or corporations, it's an even bigger whack.  Meanwhile, state and local taxes will be going up too; they have many of the same pension and entitlement problems that the federal government does.

These aren't little adjustments.  They're huge changes in the overall tax burden, and they will have big effects on peoples lives, and the economy.

So, the libs expecting tax receipts as a % of GDP to be higher than they ever have. They’re expecting them to stay at that level forever, and they’re increasing the tax burden of every person by huge amounts. She delves into some real numbers in her next post.

So our baseline would be returning effective tax rates on the top quintile to around 28%; effective tax rates on the middle quintile to 17%; and effective tax rates on the bottom quintile to 6%.  Then we raise each tax rate by a third to 37%, 23%, and 8%, respectively.  The current tax rates?  We don't know exactly (the data only go up to 2007), but a rough estimate is 25%, 14%, and 4%.

Wow, that sounds pretty big. But what does it mean to me in terms of take home pay? Well, Ms. McArdle comes to the rescue again.

Can this be done?  Maybe.  Probably, at least on the lower tiers, who don't respond to tax rates the way the wealthy can.  But it won't be easy or moderate.  I'm sure there are a number of people in my readership where two spouses take home $125,000 between them.  How easily can you guys chop $20,000 out of your budget?  And though the percentages are lower, in practical effect it's even worse for the bottom: if you're making minimum wage, $460 is several weeks worth of paychecks.

Ok, I’ll admit it. We’re in that range. $20,000 out of our budget? We could do it. Barely. But I can tell you what it’d mean. It’d mean we’d never go to Best Buy again. We wouldn’t go see movies. We’d hold on to our current cars even longer. My younger daughter would wear even more hand-me-downs. We wouldn’t replace our flooring throughout the house, which desperately needs to be done. We wouldn’t be buying that outdoor furniture we want. We wouldn’t replace our couch downstairs or the mattress upstairs. We wouldn’t take that trip to Disney next year. We wouldn’t visit the in-laws nearly as much.

Ok, that’s just one family. Now expand that nationwide. The economy would not just slow, but come to a crashing halt. And since our goal was to get the budget balanced, there’s not much we could do about the economy. We couldn’t spend more. We’d have to tax more then. We couldn’t cut taxes. We’d fail to meet our goal.

On the other hand, maybe we could cut taxes, because GDP would be so low at that point, 25% of it wouldn’t be that much.  Yeah, except the problem we’re looking at is based on rosy GDP projections. So, if GDP falters, our needs related to GDP actually go up. We might need 30%. Or even more.

And that’s why conservatives keep saying “we can’t tax our way out of this”.

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