The White House Office of Management and Budget (OMB) and the
Congressional Budget Office (CBO) both released updates of their
budget estimates for the next 10 years this week. Both reports show
staggering deficits for each year during that period. The
cumulative deficit between 2010 and 2019, or the total amount added
to the national debt, as a result of President Obama's budget will
be over $9 trillion-$2 trillion more than estimates earlier this
year.[1]
These alarming figures are sure to bring calls by some for
higher taxes to close the growing deficit. A close look at the
figures, however, shows that spending is the main driver of these
deficits. According to President Obama's own assumptions, he and
Congress can control the deficit if they limit spending to
historical levels.
Tax Revenue Grows Sharply Under
Current Policy
Deficits over the next 10 years will average close to $1
trillion a year. But contrary to claims that tax cuts created these
burgeoning deficits, close scrutiny of future tax revenue (as
estimated by OMB under current policy) shows that tax revenue will
increase significantly over the next decade.
If the 2001 and 2003 tax cuts are extended permanently (and all
income tax rates, including those on capital gains and dividends,
remain at their current levels), the death tax retains its 2009
rates and exemptions, and the Alternative Minimum Tax adjusts
annually for inflation, total tax revenue will increase from $2.3
trillion in 2010 to $4.3 trillion in 2019.[2] This 85 percent growth rate
means that Congress would have $200 billion more tax revenue to
spend each year on average.
Tax Hikes Unnecessary
Tax revenues under current policy are sufficient to keep
deficits under control if President Obama and Congress spend in
accordance with historical averages. Total tax revenue as a
percentage of gross domestic product (GDP)-the measure of all
productivity in the economy-averaged 17.9 percent since World War
II. If current policy remains law, according to OMB, total tax
revenue will also average 17.9 percent of GDP between 2010 and
2019. Similar CBO estimates reach the same conclusion.
Since World War II, spending has averaged 20 percent of GDP. If
President Obama and Congress limit spending to 20 percent of GDP,
the deficit would equal the postwar average deficit of 1.8 percent
of GDP by 2015 and fall below that level in succeeding years.
Progressive Income Tax Increases
Deficit
The current deficit would be substantial even without the
stimulus and the financial bailouts, because tax revenues decreased
sharply because of the recession. A large factor contributing to
the decrease is the steeply progressive income tax.[3]
During periods of economic growth, receipts from the progressive
income tax surge, but during periods of contraction, receipts
decline rapidly. This occurs mostly because much of high earners'
income stems from volatile sources, such as capital gains,
dividends, business income, and bonuses, and their incomes fall
just as sharply during economic downturns as they rose during good
economic times and they have less income to tax.[4]
The income tax accounts for about 45 percent of all tax
collections, so fluctuations in the revenue it raises are a large
factor determining the size of the deficit from year to year. When
Congress sets a budget for future years, it relies on estimates of
the revenue the income tax will raise in those years. If the
economy contracts in the interim, the revenue raised by the income
tax falls and larger-than-anticipated deficits result.
For example, in January 2009, the CBO estimated that the income
tax would raise $1.2 trillion in 2010.[5] Congress set its 2010
spending levels based on that assumption. However, in the period
since January, the economy continued to deteriorate. As a result,
the CBO now estimates that the income tax will raise $984 billion
in 2010-a decrease of $216 billion in just eight months. In that
eight-month span, the CBO raised its projection for the 2010
deficit by $678 billion.[6] A good portion of that increase is
attributable to the projected fall in income tax receipts.
While rapidly increasing spending is the main culprit of
record-setting deficits, the volatility of income tax receipts is
also a large factor. Even if Congress stopped its out-of-control
spending, deficits would be considerable because of this
volatility.
President Obama's plan to raise the top two income tax rates to
their levels prior to the 2001 and 2003 tax cuts would increase the
progressivity of the tax code and increase revenue volatility.
Congressional plans to slap a 6 percent surtax on top earners to
partially fund government-run health care would increase
progressivity and revenue volatility even more.
Instead of increasing the progressivity of the income tax with
these rate increases, President Obama and Congress should work to
make the income tax more like a flat tax. A flat tax would tax all
income at one rate, instead of multiple rates for higher levels of
income like the current tax code. While not a cure-all for
deficits, a flatter income tax would significantly decrease the
volatility in revenue and provide a more stable budgeting base for
Congress. As an added bonus, it would also not be a disincentive to
work, save, and invest like the current progressive income tax.
No Tax Hikes
The recently updated budget figures make clear that a lack of
revenue is not causing record deficits, so no tax hikes are
necessary to close future budget gaps. Instead, Congress and
President Obama can do so by limiting spending to the historical
average of 20 percent of GDP by:
- Reforming current entitlement programs like Social Security,
Medicare, and Medicaid to make them more efficient and
affordable;
- Dropping plans for an expensive takeover of the health care
system; and
- Eliminating wasteful and lower-priority programs.
To get further control over future deficits that result from tax
revenue volatility, Congress and President Obama should also reduce
the progressivity of the income tax by moving to a flatter income
tax code.
Curtis S. Dubay is a Senior
Analyst in Tax Policy in the Thomas A. Roe Institute for Economic
Policy Studies at The Heritage Foundation.