There is no tooth fairy. Republicans and Democrats take note.
Taxes will surely continue to play a big role in the presidential campaign. The Republicans contend that cutting rates will do the trick; the pickup in economic growth will generate additional tax revenues. Democrats retort that raising taxes on the rich will provide needed revenues to expand progressive government. Both parties are likely to be disappointed.
That’s significant, because these partisan beliefs – though dramatically different – have something in common. They obviate the need for middle-class tax increases to pay for government. This sounds self-serving and too good to be true, because it is – as studies by two Washington think tanks make clear.
Many Republican candidates have already issued detailed plans that lower personal and corporate income tax rates. For instance, Jeb Bush would replace today’s seven individual rates with three – 10 percent, 25 percent and 28 percent – and cut the top corporate rate to 20 percent from today’s 35 percent. Some of these cuts are offset by eliminating personal and business tax breaks. But not all.
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The nonpartisan Tax Foundation evaluated seven Republican tax plans and concluded that all lose gobs of tax revenues. Some estimated shortfalls are gigantic. Over a decade, Donald Trump’s plan results in a $12 trillion revenue loss. The other losses include $6.1 trillion for the plan from Sen. Marco Rubio, R-Fla. (with Sen. Mike Lee, R-Utah) and $3.7 trillion for Bush’s.
But these losses reflect static assumptions; the economy’s performance is taken as given. What if the tax changes increase growth? Couldn’t revenue losses be reversed?
To judge that, the Tax Foundation’s economic model also simulated “dynamic” gains from the tax proposals. These gains mainly involved higher business investment, reflecting firms’ ability to write off buildings and machinery in the year they’re purchased (current law spreads the write-offs over many years). The simulated gains are large. After a decade, the economy’s output (gross domestic product) is 15 percent bigger under Rubio’s plan, 12 percent under Trump’s and 10 percent under Bush’s.
But the model is artificial; it isolates the effects of tax incentives and holds constant other factors that might dampen growth (the business cycle, interest rates, the effects of budget deficits). Even under these favorable and unrealistic assumptions, most Republican tax plans still lose gobs of tax revenues. The loss over a decade is $10 trillion for Trump’s package, $2.4 trillion for Rubio’s and $1.6 trillion for Bush’s.
These proposals are certainly worth debating. Some aspects may be highly desirable, but – for Republicans – their benefits have been oversold.
The same can be said of Democrats’ faith in soaking the rich. Their political narrative seems powerful. The rich have gotten richer and don’t pay their “fair share” in taxes. Raising their taxes will temper inequality and finance good causes. Redistribution becomes an engine of social justice. The trouble is that the math doesn’t match the rhetoric, as a new Brookings Institution study shows.
In it, economists William Gale, Melissa Kearney and Peter Orszag asked this question: What would happen if the top income tax rate were increased from 39.6 percent to 50 percent? The answer – less than you think.
For starters, it would raise about $100 billion in tax revenues. That seems like a lot (and is), but it’s actually slightly less than a quarter of the $439 billion budget deficit for fiscal 2015. Never mind paying for new programs. Even if the $100 billion were directly distributed to the poorest fifth of Americans (an average $2,650 for each household), the effect on overall inequality would be “exceedingly modest,” the authors say.
There is a broader message here. Both parties have constructed rationales for avoiding middle-class tax increases, which would be highly unpopular. It’s not that these rationales are illegitimate: The effect of tax policies on economic growth is clearly important; similarly, redistribution is a central function of the welfare state. But the resulting tax policies don’t come close to covering the realistic costs of government.
For years, budget deficits have straddled the contradictions. The trouble is that the mounting costs of retiring baby boomers have made this solution less and less tenable. The present campaign rhetoric will ultimately prove hollow.
If middle-class Americans need or want bigger government, they will have to pay for it. Sooner or later, a tax increase is coming their way. There is no tooth fairy.