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A Dubious Deal For Reduction In Entitlements
Investor's Business Daily
June 30, 2006
By Ernest S. Christian and Gary Robbins
Rumors are circulating that Republicans may
by next year be desperate enough to accept tax increases in
exchange for decreases in entitlement expenditures. This would
be part of a bipartisan deal designed to postpone the fiscal
calamity that will occur when currently promised entitlement
benefits become totally unaffordable.
Wholly apart from whether any "grand compromise"
involving tax increases is a good idea (it isn't) or whether
the Democrats can be trusted to do a clean deal on permanently
reducing entitlements and stick to it (they can't), anybody
planning to participate in such a high-risk game should at
least start off with the right facts and figures. Otherwise,
well-intentioned seekers after fiscal sanity - not to mention
the voters - will get sucker-punched again.
Bad Voodoo
According to the voodoo budget accounting rules in use by
both the administration and Congress, $1 of additional tax
revenues for the government costs the private sector only
$1 - and that $1 in taxes is equal to $1 in spending. Looked
at in this self-delusional way, a dollar-for-dollar swap of
tax increases in exchange for spending cuts might sound good
on the evening news, and it would indeed help balance the
government's accounts in a mindless bookkeeping sense.
But the shocking truth is that each $1 of tax increase actually
costs the private sector economy $2.50 - and, in some circumstances,
much more. Thus, instead of a dollar-for-dollar swap, as advertised,
for every $1 of spending reduction, there would be at least
$2 of a tax increase, part of which is visible and part of
which is hidden.
The visible part is the $1 that is paid into the IRS' coffers
and officially counted. The hidden part is the amount by which
people's wages, salaries and other pretax incomes are smaller
in the first place - before any check is written to the IRS
- solely because of the economy's negative reaction to the
tax increase.
It has long been known among analysts in and out of government
that tax increases adversely affect economic growth; that
$1 of additional tax, therefore, reduces pretax and after-tax
incomes; and that, when correctly accounted for, the total
is substantially greater than $1.
A new study by the National Bureau of Economic Research
at Harvard confirms that the total cost of raising $1 of additional
tax is about $2.50. Our model produces almost identical results
($1 of visible tax plus $1.57 of "lost" wages, salaries
and other income).
Recent calculations by the Congressional Budget Office produce
similar results in the case of an across-the-board tax increase
on both labor income and capital. A tax increase solely on
capital - such as upping the tax rate on dividends - costs
about $4.30 per $1 of revenue raised, according to the methodology
used in a new study by former Bush administration economic
adviser Gregory Mankiw, also at Harvard.
The Truth Is (Almost) Out There
The Treasury Department's own newly established Dynamic Analysis
Division is, itself, well on the way to confirming and quantifying
the high costs of tax increases - and, if allowed to fully
develop its capacity, will for the first time in history soon
be telling Americans the truth about how much tax (visible
and invisible) they are paying.
Once voters know the truth, tax increases that help the
government balance its cooked books but make people worse
off by a ratio of at least 2-to-1 will not be very appealing.
Even high-tax Democrats will be restrained when the voters
learn that the economic burden of high "taxes on the
rich" actually falls mainly on low- and middle-income
wage earners.
The first thing that incoming Treasury Secretary Hank Paulson
should do is make his department's fledgling Dynamic Analysis
Division a matter of the highest priority, expanding its resources
and broadening its mandate to look at the economic consequences
of spending as well as taxes. That way, voters will know that
cutting spending is in most cases conducive to economic growth
in much the same way that raising taxes is harmful to economic
growth.
On the congressional side, more members should follow the
statesmanlike example of Sen. Judd Gregg, chairman of the
Senate Budget Committee, who has introduced S. 3521 that would
face up to the entitlement crisis by cutting spending. And
all members of Congress should enthusiastically follow the
lead of Rep. Paul Ryan, the likely next chairman of the House
Budget Committee, whose Legislative Line Item Veto Act of
2006 was recently passed by the House.
Lower spending means lower taxes, and the combination of
the two means economic growth and higher incomes.
Christian is executive director and Robbins chief economist
of the Center For Strategic Tax Reform, a Washington-based
think tank. They are also visiting fellows at the Heritage
Foundation.
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