Draft: To Spend Is to Tax

We economists have a scenario that we call "current policy plus Bush tax cuts." It is made up of (i) the laws currently in force in the United States of America, plus (ii) the assumption that the defense, veterans, and other spending currently appropriated year-by-year by the congress remains the same as a share of GDP, plus (iii) the assumption that the tax breaks like the R&D credit and the regular pruning-back of the Alternative Minimum Tax that are voted for year by year by overwhelming congressional majorities continue to be enacted year-by-year, plus (iv) the assumption that the tax cuts George W. Bush proposed in 2001 and 2003 but made time-limited and set to expire early next decade are renewed. This "current policy plus Bush tax cuts" scenario has the federal government taxing about 20% of GDP over the next seventy-five years. It has the federal government forecast to spend 28% of GDP on average over the next seventy-five years. This is the fiscal gap.

A number of policies could be enacted to eliminate this fiscal gap. Simply doing nothing and letting the Bush tax cuts expire as current law requires them to do would reduce the fiscal gap from 8 percent to 6 percent of GDP. Raising Social Security taxes or cutting back future Social Security benefits by the about 1/7 needed to get the Social Security system back into projected 75-year balance would further reduce the fiscal gap from 6 percent of GDP to 5 percent of GDP. Returning military spending to its late-1990s share of GDP--not fighting wars in Iraq, et cetera--would reduce the fiscal gap from 5% to 3.5% of GDP. And eliminating "excess" cost growth in the government health care programs Medicare and Medicaid--allowing Medicare and Medicaid spending per eligible beneficiary to grow only as fast as the rate of growth of income in the economy as a whole--would bring the federal government into projected balance.

I believe that when we Americans look deep into ourselves and ask us what we want our government--because it is our government: it is our agent to do what we want with our money just as the guy in Florida we hire to keep grandma's one bedroom condo in repair is our agent--to do, we conclude the following:

1. We want to let the Bush tax cuts expire.
2. We want to close the 75-year Social Security gap, half by raising the limit on earnings taxed by Social Security so that the upper middle class and the rich pay more for Social Security and half by reducing the rate of growth of benefits at retirement.
3. We want to stop sending our soldiers--the best-trained and best-equipped high tech armed forces in the world--abroad to be military police in countries riven by sectarian conflict where they do not speak the language--and so return defense spending to its late-1990s share of GDP.
4. We want to reduce but not eliminate the "excess" cost growth in Medicare and Medicaid: we believe our doctors, nurses, and druggists will learn how to do wonderful things over the next two generations, and we do not want those wonderful things in the way of medicine applied only to the rich but to the poor and old as well.
5. Whether or not we decide to do (1) through (4) above, we want to raise taxes to cover whatever of the long-run fiscal gap remains, and so bring the federal budget back into balance over the long run.

Note that (5) is not optional. As the late Milton Friedman liked to put it: to spend is to tax. If the government buys things, it must get the money to buy them from somewhere. It can get the money from three places. It can tax. It can borrow--but then the borrowing has to be repaid with interest, and the more is borrowed the higher the interest and the worse the value the taxpayers ultimately get for their money when they are taxed to repay the borrowing. Or it can print the money and so inflate the currency--but that too is a tax, and an especially unfair, painful, and destructive one, as lots and lots of people victimized by inflation find their wealth doesn't buy what it used to and what they expected.

We can argue over whether (1) through (4) is what we want to do--that is what politics is about. But whatever we decide to do with (1) through (4), (5) is not optional--not, that is, if we want to continue to have a rich country in the long run. And the politicians who have told you that (5) is optional from Ronald Reagan to George H.W. Bush to Robert Dole to George W. Bush and now John McCain are not your friends, or America's friends.

Comments

[Robert Waldmann]

I don't see why you wrote "not, that is, if we want to continue to have a rich country in the long run. " after arguing that (5) is not optional at all.

It may be true that when "we Americans look deep into ourselves" we want to cut social security benefits. However, when we are asked by pollsters most of us say otherwise. In contrast, most US adults want to raise the the limit on earnings taxed by Social Security. The polls are clear. The polls are here

http://www.pollingreport.com/social.htm

I only see support for cutting the benefits of the more affluent.

Now no one asked about an Obama doughnut approach. I would guess that that would be even more popular, although, fearing that he will be accused of not increasing the deficit, Obama has scaled it down to nothing much.

Odd that you present yourself as being less egalitarian than the median American. You aren't fooling me.

[Denis Drew]

What in the world is with the 75 year Social Security balance?

If you want to keep the FICA rate the same for 75 years you could set it in the middle of what you think it will be half way through that span and it will generate a surplus which you would spend on on-budget items for the first half of that span and drop government owned bonds into the "balance" kitty. Then for the second half you would make up the retirement short fall with income tax by "cashing" government owned bonds from the kitty.

Then what; the world ends?

No; this system is to be kept in place forever. Leading us to forever raise the "mid-term" rate -- leading to forever paying for a portion on-budget items with regressively raised FICA funds and never "cashing" the government owned bonds in the kitty (I'm not completely sure why FICA is not progressive in the first place, but I'm not that smart).

I (think) I am just beginning to understand this.

In the case of Medicare and Medicaid balances: as future pay out projections climb exponentially with the projected exponential future rise of medical care costs, are we supposed to exponentially raise the "mid-term" rate on today's taxpayer who will neither enjoy the benefit of the future medical miracles nor has the benefit of future multiplied incomes (if not multiplied nearly as fast as medical costs) with which to pay for tomorrows higher costs.

Do I have this all wrong?

[George]

Medicare and Medicaid are what are going to bankrupt us. I agree with David Walker when he says that more people need to Demand Accountability from their politicians.

[MattY]

"[spending] 28% of GDP on average over the next seventy-five years."

Impossible. The federal government will take on average some 19.7% of the economy over the next 75 years. (I am still following Hauser's law)

The issue is whether congress is efficient enough to match the expected share of government with the legislated share. Congress is likely to freeze up and other, more disasterous actions will get us to the magic 19.7%.

[Nat]

Numbers 2 and five are really the same thing. The quibble is: payroll taxes off the top or income taxes?

Reducing the rate of growth is a renege of the deal in '83. It is a defacto value judgment that it is preferable to short change those who have worked for 45 years than it is to raise revenue commensurate to meet this obligation.

No one in their right mind should trust any US government with the pay ahead process of the trust fund given recent events and statements. It is a defacto current income tax cut for the wealthy. Excuses will be found to not meet the retirement obligation. Never trust Wimpy to pay you back Tuesday for the hamburger today.

The entire problem of the so-called shortfall should be handled when it occurs and no sooner. As Max Sawicky pointed out long ago, the year the trust fund runs out we will face this decision: either cut taxes and cut the incomes of retirees or keep the status quo. I will be long dead by then but I like the politics of that dilemma. I imagine it will be tough to cut the income of millions of retired individuals.

[Denis Drew]

Assuming the trust fund is not supposed to keep a (sliding) 75 year balance forever -- I cannot tell listening to various discussions...

...we would not likely let the trust fund run down lower than something like 5 years short of running out -- the only sensible purpose of a trust fund in the first place being having an automatic funding bridge to cover retirement should the FICA rate no longer produce sufficient revenue; allowing Congress enough space to get its rate raising act together.

Whenever we decide to stop "cashing" government owned bonds, we can just drop the income tax rate (the tax doing the "cashing") and up the FICA rate proportionately. The whole 75 year thing has been pretty clunky from the word go if you ask me (it can be made to sound like baby boomers were saving for their own retirement -- the original idea I am afraid).

At that point, if doubled average income plus whatever multiple higher percentage of population are retirees cannot keep S.S. retirement going full out -- any moral obligation supposedly created by trust fund bonds is going to be a relatively tiny motivational factor.

Once retired pop percentage stabilize around 2050, S.S. retirement could turn into a reverse Ponzi scheme: each retiring generation having more per capita income to soak from the current generation of workers than was available to be soaked from them. But that's the way it should be.

[arbogast]

"Or it can print the money and so inflate the currency--but that too is a tax, and an especially unfair, painful, and destructive one, as lots and lots of people victimized by inflation find their wealth doesn't buy what it used to and what they expected."

I admire your concern for creditors.

[MattY]

"I'm not completely sure why FICA is not progressive in the first place, but I'm not that smart)." Denis asks.

The point about retirement investment is the same for all investing, and I can quote Brad over and over, spread the risk and hold for the long term. It is a proven, in theory and practice, theory, proven more correct than not.

Hence the rub for SS, if you do not invest and pay out according to the wealth distribution than Brad's condition will not be met, the system will not be optimal. Operating a badly run SS system, as Goolsbee wants us too, is nothing short of stupid, forcing middle America to live in an inefficient retirement system.

You would be, in the age of global warming, forcing a major part of the economy to operate suboptimal.

Progressivity in income taxes was designed to keep the wealthy from manipulating congress, we never intended it for redistribution.

[Barry]

Brad: "Raising Social Security taxes or cutting back future Social Security benefits by the about 1/7 needed to get the Social Security system back into projected 75-year balance would further reduce the fiscal gap from 6 percent of GDP to 5 percent of GDP. "

J*s*s H. Chri*st, is it physically possible for a G*d-d*mned elite econowh*re to *not* lie about Social Security?

[Barry]

Brad, evidence that being an elite economist [1] does *not* mean that one has to propagate SS lies:

http://krugman.blogs.nytimes.com/2008/08/24/social-security-zombies/

-Barry

[1] Albeit probably excommunicate in the ranks of the Very Serious Economists.

[mpowell]

I'm okay with an increase on the cap on SS payroll taxes, but only in combination with a hefty increase on the income tax in the top tax bracket. I fall into the category of income greater than payroll taxes, but not top income bracket, so some might see this as self-serving. But I think it's only fair that if you're going to increase my net tax share, you increase the net tax share of those far wealthier than me as well.

[Steve Roth]

Just to add one data point on "what we want":

According to today's NYT/CBS poll, 67% of voters think it's "more important to provide health care coverage for all Americans" than to "hold down taxes."

Apparently when given the choice between death and taxes, most Americans prefer taxes.

Steve
http://trueconservative.typepad.com

[MattY]

"more important to provide health care coverage for all Americans" than to "hold down taxes."

Until they are required by government to pay the $3,000 to $7,000 premium needed. As in Mass, where the costs of government's expanded health coverage in the face of rising medical costs and little rationing set up is causing large budget deficits.

[economistmom]

Brad: I'm with you and love this post. I want to feature it over at my place. (And your house is beautiful! What color did it used to be?) --Diane