Monday, August 22, 2011

How High Would Taxes Have to Be to Close the Budget Gap This Year? - Update

About a month ago, I posted a table of what income tax rates would have to be for us to balance the budget strictly on increasing taxes, helping us visualize how much we overspent.  That was based on 2008 numbers because, the IRS being a government organization, that was the most recent data at the time.  Given how relatively low the unemployment rate was at this time (the range was 5-7.3% during the year) one could argue that the relatively dire rates calculted using 2008 numbers might even have been optimistic.  As the IRS has just updated it's website with 2009 numbers, I felt it was a good time to update the original table.

As you can see, things are definitely worse.  We can tax Warren Buffett and everyone who makes $10 million a year at 100% and we wouldn't even come close to balancing the budget this year.  Their tax rate would actually have to be almost 700% for us to do that, which is obviously impossible.  We couldn't even close the budget deficit by taxing everyone making above $200,000 at 100%, even theoretically (also remember, if we take 100%, what would the state and local authorities get, as there would be nothing left over for them).  And evenif you make the tax increases across-the-board, the effective tax rate would have to practically triple for us to balance the budget, a politically untenable solution.

The worst part about the above chart is that the reality would actually be much worse as this table assumes no negative impact on the economy of said taxes.  Obama's former Chair of the Council of Economic Advisers, Christina Romer, found that the multiplier on taxes is 3.  So for every $1 in tax cuts, $3 is added to the economy.  It doesn't take a rocket scientist to realize the reverse is true.  For every $1 in tax increases, $3 is taken from our economy.  So if you close a $1.6 trillion budget gap through tax increases (and there won't be any offsetting spending in this scenario as you are trying to balance the budget) you would have $4.8 trillion leave the economy, an equivalent of 34% of GDP!

What about spending?  As Robert Barro points out, the multiplier on government spending is probably less than 1.  So for every $1 in government spending only $0.80 gets into the economy.  That seems true doesn't it?  If it were greater than 1, our economy probably would be zooming right now given the level of stimulus.  Instead we are headed back into recession.  I know many people like Paul Krugman are saying this is the worst time possible to cut spending as we are rolling over again.  But what if we coupled spending cuts with permanent tax cuts so that the negative economic impact of the spending cuts was counter-balanced by the positive impact of tax cuts.  Seems like a great way to get out of our current mess.

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