Tax Alternative

by Jonathan Cohn | March 28, 2005

Alan Greenspan's appearance before Congress early this month provoked plenty of criticism. And rightly so. The longtime chairman of the Federal Reserve had been asked to comment on the government's failure to control budget deficits and the economic danger those deficits pose. But Greenspan was no innocent bystander to this act of gross fiscal negligence. In 2001, back when the budget was still in surplus, Greenspan urged Congress to enact President Bush's proposed tax cuts; two years later, even after those surpluses were gone, Greenspan endorsed yet another round of Bush tax reductions. Given that the latest projections show the government running budget deficits for the foreseeable future--thanks in no small part to those tax cuts--Greenspan owed Congress an explanation, if not an outright apology. Instead, he just bemoaned how "the brief emergence of surpluses in the late 1990s eroded the will to adhere to" balanced budget rules--as if he had nothing to do with it. Even Los Angeles Times columnist Ron Brownstein, perhaps Washington's most congenial pundit, had to ask, "Is he kidding?" But the most unfortunate part of Greenspan's testimony wasn't what he said about the past. It was what he said about the future. As discussion turned to the retirement of the baby-boomer generation and the financial strain they will place on Social Security, Medicare, and Medicaid, Greenspan urged Congress to take preemptive action by cutting those entitlement programs down to size. "I fear that we may have already committed more physical resources to the baby- boom generation in its retirement years than our economy has the capacity to deliver," Greenspan explained. The government's goal, he said, should be to "close the fiscal gap primarily, if not wholly, from the outlay side"--in other words, by drastically reducing the money those programs spend on their beneficiaries. Nobody seemed to find this part of the testimony particularly controversial-- perhaps because, around Washington, it's not controversial to insist that preparing for the baby-boom generation should consist largely of reductions of the entitlement programs on which they will rely. But, unless Republicans have somehow managed to repeal the laws of mathematics (hey, you never know, they're pretty resourceful), there's another way to balance the federal government's books. Rather than concentrate primarily on reducing the money we take from the federal treasury, we could try putting more money into it. In other words, we could actually raise taxes. Although it is politically taboo today, there was a time when government didn't flinch from raising taxes, just so long as there was a legitimate need to finance new spending. This would seem to be just such an occasion, thanks to three increasingly urgent claims on federal money: protecting Americans from terrorists, providing the aging population with retirement benefits, and patching up (or replacing) the employer-based health insurance system. These are all vital public needs that only the government is in a position to meet, either because they require collective, coordinated action (like maintaining an army) or because they provide a service that the free market won't (like giving the elderly health insurance). Clearly, modest reductions in some programs or services should be part of any long-term budget strategy. But, overall, there's a compelling case for the government spending a great deal more money than it does now. And, while a robust economy can increase tax receipts all by itself, raising more revenue would inevitably involve raising at least some tax rates. One reason this option doesn't get the attention it deserves is that most of the Washington establishment thinks it would, as Greenspan put it, "pose significant risks to economic growth." It's certainly true that, if taxes become too high, they can slow an economy by, among other things, reducing incentives to work or interfering with the market's ability to allocate goods and services efficiently. But the United States is far from that point. Thanks to the Bush tax cuts, our relative tax burden is far lower than it was in 2000. In fact, it hasn't been this low in half a century. Simply repealing the Bush tax cuts would cover the long-term shortfall in Social Security while leaving some extra money for other purposes. And, far from imperiling the economy, it would merely restore tax rates to what they were late in the Clinton era, a time when the economy was doing extraordinarily well. Taxes would probably have to go higher still in order to finance major new spending on homeland security and sustain relatively generous retirement benefits and cover vast expansions of government-provided health insurance. But there may be room for some of that, too. The relative U.S. tax burden--measured, again, as a percentage of the overall economy--is the lowest in the developed world. And, while high taxes in Europe have sometimes choked economies there, there is an enormous middle ground between the United States, where taxes are 25 percent of gross domestic product, and Sweden, where taxes are 50 percent of gross domestic product. (Besides, Sweden's economy has actually been performing pretty well lately.) Most voters would undoubtedly prefer lower taxes and higher benefits, a fantasy the Republican majority has indulged by passing huge tax cuts without offsetting spending cuts. But, sooner or later, the voters will have to confront real trade-offs, if only because the financial markets won't let excessive deficits continue forever. And the early signs suggest that Americans might be more hospitable to tax increases than everybody has long assumed. Skittishness over benefit cuts obviously has a lot to do with the sinking support for Bush's Social Security privatization plan; among the options for improving Social Security's finances, by far the most popular solution is raising the limit on taxable income. And, as a recent Washington Monthly article by Daniel Franklin and A.G. Newmyer III points out, even Republican governors like former Bush administration budget director Mitch Daniels (now the governor of Indiana) have recently backed tax increases for their states in order to avoid cuts in services. Greenspan would surely argue that raising taxes in this way invites economic calamity. But, given the maestro's recent track record, maybe that means it's the right idea.

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