Dead ideas on taxes
The Washington Post, November 21, 2012
As the "fiscal cliff" drama heads toward its climax between Thanksgiving and Christmas, each party is in the grip of a dead idea on taxes that warps the conversation. That means that no matter who "wins" this showdown, the parties' antique thinking guarantees that any deal they strike will be merely the first of much bigger future adjustments as the baby boomers retire. To see why, it's useful to think of the United States' tax debate as being trapped between the cobwebs cluttering Grover Norquist's mind and those clouding Gov. Jerry Brown's.
Norquist's dead idea is that we can fund the federal government in an aging United States without higher taxes. Republicans love to say federal taxes should be what they've always been in the post World War II period—around 18 or 19 percent of GDP. That's why they want spending to come down from today's recession-inflated 24 percent of GDP toward post-war norms of around 20 percent. (Revenue has fallen off a true fiscal cliff to 15 percent of GDP, thanks to the sluggish economy). Balance the budget around 19 percent of GDP, Republicans say, and call it a day.
The flaw in this reasoning is that we're on the verge of doubling the number of seniors on Social Security and Medicare. Ronald Reagan ran government at 22 percent of GDP when the United States' population was much younger. Even after we take steps to slow the growth of our health and pension programs (which we must), it's impossible to fund the boomers retirement at historic levels of taxation and balance the budget without decimating government activities devoted to non-elderly purposes—including the R&D and infrastructure that help propel future growth.
Sorry Grover—in an aging America, federal spending, and taxes, are destined to rise.
The Norquist-Paul Ryan reaction is to deny math and demography. They want to use this "historical norm" tax limitation and our aging population to force big cuts in the rest of what government does. But their equally powerful motivation is political: they desperately want to preserve the tax issue as the chief way voters can distinguish what Republicans stand for.
After all, if Republicans don't stand for lower taxes, what contrast do they have with Democrats? How can they contest elections? Ever since 1980, when Reagan put tax cuts at the heart of the GOP agenda, the party's had a great ride on the issue. But the aging of the population means this centerpiece of Republican economic "thinking" is now totally divorced from reality.
If Republicans can't run on tax cuts, they'll actually have to come up with other policies to improve Americans' lives. As we've seen in their flailing since the election, the party is so out of practice at doing this that they're not sure where to begin. But despite Norquist's death rattles, the GOP ultimately has no choice.
Democrats have a dead idea on taxes, too: the notion that we can put our fiscal house in order only by raising taxes on top earners. Obama ran hard on this myth, but the prizewinner this year is Gov. Jerry Brown, whose Proposition 30 raises marginal income tax rates on top earners in California to a whopping 13.3 percent, the highest in the nation.
To be fair, Brown knows that relying so heavily on a handful of taxpayers is bad policy. His original plan was to raise sales taxes as part of a broader budget patch, but the teacher's union planned a rival ballot measure aimed squarely at the rich. Wealthy attorney Molly Munger backed her own tax plan as well (that's what we do out here in California—everyone who's anyone tries to govern by proposition).
Brown reckoned that if there were three tax hikes on the ballot, they'd all fail. So he cut a deal with the unions to get behind one that resembled theirs. "He came to this compromise because he had no other political choice," says Dan Schnur, director of the Jesse M. Unruh Institute of Politics at USC.
As a result, while Prop 30's passage saves schools from devastating cuts for the time being, Brown has planted the seeds of future trouble. Follow the numbers: let's say federal tax rates on top earners go back to 39.6 percent from 35 percent. Add in Obamacare's new 3.8 percent tax on investment income and new 1 percent higher Medicare payroll tax on the same folks. Then toss in new top state rates of 11.3 to 13.3 percent (up from 9.3 and 10.3), and presto! Marginal tax rates for self-employed people in California earning $300,000 and up (who pick up both "sides" of the payroll tax on a chunk of their earnings) could reach 55 percent or more.
That's dicey. It will almost certainly affect incentives and behavior. Yet Prop 30's new inflow of $7 billion a year in a $100 billion budget won't fix the state's long-term budget woes, which are driven by spiraling health costs and massive unfunded health and pension benefits—not to mention sweetheart deals like those won by the powerful unionized prison guards, on whose slim ranks California now showers three times more cash each year than it devotes to its system of higher education.
The point? At both the state and federal level, middle class benefits and government services can't be funded in a sustainable way just by ratcheting taxes ever higher on the top. Eventually middle class benefits and services must be supported by the middle class.
So we'll need higher taxes, Grover, but not just on the rich, Jerry.
Neither party is ready to give up its dead idea yet. Which means we won't get the debate we need anytime soon. That debate is this: Given that tax hikes in an aging United States are inevitable—including on the middle class—what's the best and fairest way to do this with the least harm to economic growth?
This is the real "tax reform" conversation we need, and it would take us far beyond the approved Simpson-Bowles vocabulary that limits tax reform to the mantra of "lowering rates and broadening the base." For starters, in an aging America we should be looking at slashing payroll and corporate taxes to boost jobs and growth and raising taxes on consumption, dirty energy and financial securities transactions to fund the government we want.
Whether we avert, postpone or go off the cliff next month—or some blend of all three—this is the conversation we'll still need to get to in a few years.