When a Spending Cut is Really a Tax Rise, and Other Logic-Defying Mysteries

by Charles Krakoff on July 29, 2011

in Crisis and Recovery, Economics, Growth, High Crimes and Misdemeanors, Politics, The Markets, United States

Marco Rubio, the Tea Party-leaning freshman Senator from Florida, recently said something remarkably intelligent, if self-evident, which appears to elude most Washington policy makers. “We don’t need more taxes,” he said, “We need more taxpayers.”

This is axiomatic for anyone trying to reform tax systems and increase government revenue, which I have done in a number of countries in Africa and Asia. In most of these countries, as well as in places like Greece and Italy, most people (and companies) do not pay taxes, at least not officially. Tax administrations are both inefficient and corrupt; if you’re lucky you will never attract the attention of the taxman, and if you’re not, a bribe – possibly significant, but almost certainly less than your true tax liability – will do the trick. And when garbage piles up in the streets and public money vanishes into the pockets of corrupt politicians and bureaucrats, it is natural for citizens to decide government is not worth whatever taxes they are supposed to pay.  In most of these countries, it is foreign individuals and corporations, who lack the proper connections, who are not steeped in the arcane rules of the game, and who try to obey the law, who shoulder much of the tax burden. The cell phone company, the brewery, and the oil and mining companies – and their foreign employees – are easy and highly visible targets, and governments never tire of trying to change the rules, imposing new taxes or demanding a share of the company.

The United States, of course, is not Nigeria or Greece. As hard as it may be to follow the letter of the law when the tax code runs to 10,000 pages, most people and companies try their best, exploiting whatever advantages they and their accountants can find, but rarely committing any deliberate infractions, cash payments to the guys who help carry your furniture up to the second floor apartment notwithstanding. The IRS is too effective, and the penalties too great, for most of us to chance it. And, at least until now, most Americans have thought that paying taxes is one’s duty as a citizen.

Nevertheless, we face two enduring paradoxes. Though U.S. personal income tax rates are low by international standards, half the population pays no Federal income tax at all. Normally, one way to increase the number of taxpayers is to lower rates, but in the U.S. low rates have not expanded the tax base, partly due to President Obama’s pledge not to raise taxes on anyone earning less than $250,000 a year, and partly because of the Republicans’ hatred of taxation in all its forms. So the percentage of the population that actually pays taxes continues to shrink and, inevitably, their share of total taxes paid continues to rise. You don’t have to be a George Bush Republican to know that you can’t balance the budget even by imposing confiscatory taxes on the well to do.

On the corporate side, the U.S. has some of the highest tax rates in the world. Among the members of the OECD club of high-income countries, only Japan has a higher corporate tax rate. Yet the actual take is, proportionally, lower than that of many countries with much lower headline tax rates. Earlier this year, there was substantial outrage when it transpired that several major blue chip American companies, including General Electric, not only paid no Federal income tax, but actually received tax refunds. But the outrage was misplaced, directed at the supposed trickery and greed of these corporations instead of the tax code, a big chunk of which contains a plethora of tax credits and exemptions for large businesses engaged in activities enough membersof Congress has been persuaded are in the national interest and thus worthy of subsidies. Most of these are well-hidden somewhere in those 10,000 pages, so few people, except the beneficiaries, know about them.

You would think some kind of bipartisan consensus to get rid of these subsidies and exemptions could quickly emerge. After all, few members of Congress, Republican or Democrat, are willing to actually stand up in public to defend tax breaks for the Fortune 500. And the impact could be enormous. The bipartisan Erskine-Bowles deficit commission reckoned that elimination of these “tax expenditures” could increase tax revenue by over a trillion dollars a year, even while the headline corporate tax rate could be reduced by up to 10 percentage points. But you would be wrong. In a twisted kind of logic, Republicans have managed to persuade themselves that eliminating this kind of corporate welfare, even as the tax rate goes down, constitutes a tax increase. Eric Cantor, House Majority Leader, with Grover Norquist cheering from the sidelines, has insisted that any elimination of corporate tax loopholes must be compensated by corresponding spending cuts, so as to remain revenue neutral. Anything that increases tax revenue, even if it leaves tax rates unchanged, is taboo. Even Harry Reid has been forced to propose a deficit reduction plan that contains no revenue increases.

You would think that not even the most dedicated ideologue could maintain with a straight face that getting rid of tax loopholes that distort business decision-making and reduce economic efficiency is really a tax increase, or that leveling the playing field so that all companies pay more or less the same share of their income in taxes is a bad thing.

But this argument is not about balancing the budget, it’s about starving the Federal government of revenue. The Republicans’ new proposal, “Cut, Cap and Balance,” calls for government spending to fall from 25.3% of GDP to 19.9% by 2019, never again to rise. Rep. Paul Ryan’s deficit reduction plan went even further, seeking to cap federal spending at 18% of GDP. Others in the Tea Party movement, noting that from 1787 to 1930 federal spending averaged around 2.5% of GDP, think 18% is way too much and would like to see it scaled back to, say, 10%. John Boehner wasn’t kidding when he said that his party and the President’s party have different visions of where they want the country to go.

A discussion of how limited limited government should be, or how big big government should be allowed to become, especially in view of the budgetary and demographic time bombs that are Social Security and Medicare, is worth having. But a philosophical discussion of this kind should not take place with default only days away. No matter how they try to spin it, if the Congressional Republicans who are determined not to raise the debt ceiling have their way, it could well be the end of the Republican Party. We can save the discussion about whether that is a good or a bad thing for another day.

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