[Vision2020] The Truth About Taxes

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August 6, 2011
The Truth About Taxes
A week later and we are still amazed at how the Republicans in Congress pulled it off. They held the economy hostage, won some cheap political points, and all of us will spend the next decade paying the ransom as government programs - $900 billion over 10 years in the first round - are slashed and the recovery is put at risk. 

The only glimmer of hope is that the battle is not completely over - if President Obama is finally willing to fight. 

Under the terms of the ill-conceived debt agreement, Congress has to propose another $1.5 trillion in deficit reduction measures by December. Just to ensure that rationality does not have a chance, Republican leaders said they would not put anyone on the deficit-cutting "super-committee" who might entertain the idea of raising taxes. 

A week later and we are even more amazed by the failure of Mr. Obama and the Democratic leadership to stand up to this intransigence. If they do not start pushing back, with the same ferocity, the results will be disastrous. 

Standard & Poor's made its judgment about both the political standoff and the all-cuts, no-new-revenues deal on Friday when it lowered the country's long-term debt rating one notch, down from AAA. And while "no new taxes" pledges are almost always big political winners, Americans are also figuring out that the country cannot keep on this way. According to the latest New York Times/CBS News Poll, 63 percent support raising taxes on households that earn more than $250,000 a year to help address the deficit. 

If that is not enough to energize the White House, here are a few more facts. To avoid across-the-board cuts, Congress must enact at least another $1.2 trillion in deficit reduction measures over the 10 years. For all of the talk of "big government," there is no way to cut that much in discretionary programs without crippling basic functions. Lawmakers could eliminate the Federal Bureau of Investigation, Pell Grants, the Centers for Disease Control and Prevention, the National Institutes of Health and Head Start and still not cut $110 billion annually. 

Entitlement reform is essential. But it is unlikely that lawmakers will agree on deep cuts to Medicare, Medicaid and Social Security. Finally, asserting that deficits can be tamed with spending cuts alone ignores that the Bush tax cuts - costing $1.8 trillion from 2002 to 2009 - are a big reason we got into this deep hole. 

Here is the bottom line. There is no economically sensible or politically honest way to address the deficit without also increasing revenues and reforming the tax code. The major challenges are these: 

LET THE BUSH CUTS EXPIRE Mr. Obama vowed to let the high-end tax cuts (for people making more than $250,00) expire in 2010. But in a preview of the debt fight, he agreed to extend the cuts for two more years when Republicans held unemployment benefits and other measures hostage. 

Letting all of the cuts expire at the end of 2012 would save $3.8 trillion over the next decade. Letting the tax cuts expire for those making more than $250,000 would save $700 billion. That would make a real dent in the $2.4 trillion in total deficit reduction envisioned in the debt limit deal. 

A sensible and fair approach would be to let the high-end tax cuts expire as scheduled, but keep the other tax cuts for another year. That would keep more cash in the hands of people most likely to spend it and prop up consumer demand while the economy is weak. It would give Congress and the administration time to undertake tax reform. 

MAKE REAL REFORMS Most Congressional Republicans are willing to embrace reform, but only if it is "revenue neutral." There is no question that the system is overly complicated; it is also riddled with hugely costly special deals for special interests. Any reform must streamline the code, make it fairer and - most important - raise more revenue. 

TARGET TAX BREAKS AND LOWER RATES Each year, the government provides $1 trillion in tax breaks. Some of the largest breaks - for itemized deductions and retirement savings - should be retained because they subsidize important goals, like home ownership and old-age security. Right now, wealthier taxpayers get the greatest benefit. The process needs to be reformed so that most of the help flows to those who most need it: low- and middle-income taxpayers. 

At the same time, super-low tax rates for investment income should be ended. Capital gains are taxed at a top rate of 15 percent, compared with a top rate for wages and salary of 35 percent. Proponents argue that the lower rate is an incentive to invest, but research shows that it also encourages gaming of the system. Tax breaks that have outlived their purpose must be ended, starting with subsidies for the oil industry, which is making billions in profits. 

The revenue from such reforms could be used to pay down the deficit and allow all tax rates to be lowered, improving incentives to work. The amount of revenue raised and the drop in tax rates will depend on how much tax breaks are curbed. 

OTHER TAXES Congress should consider raising revenues in other ways, like a value-added tax, or carbon taxes. That way all of the needed revenue for deficit reduction, and for what government provides, does not need to be squeezed from the income tax. A value-added tax is conducive to saving, and a carbon tax helps protect the environment. 

The public is open to new taxes, and the economic facts are clear. Until tax increases are considered in equal measure to spending cuts, there will be no budget fix.

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Wayne A. Fox
wayne.a.fox at gmail.com
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