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Can we just tax our way out of deficits?

January 26, 2010

Can we fix our budget problem by raising income taxes alone? With deficits as far as the eye can see, Rosanne Altshuler, Katie Lim, and I presented a paper at last week’s TPC/USC budget conference that came up with a fairly straight-forward answer: No.

For the record, TaxVox is the blog of the Tax Policy Center, a joint policy venture of the Urban Institute and The Brookings Institution -- no right-wing Scaife/Koch-funded think tank (not that there'd be anything wrong with that).

What if Congress just raised taxes for high-income taxpayers? Their rates would go up more than 40 percent under current law and more than 150 percent under current policy. In other words, the top tax rate would return to the bad old days of 90 percent. Even if we go for the Administration’s more modest goals—start with current policy and aim for deficits averaging 3 percent of GDP—those top tax rates would have to more than double, taking the top rate over 75 percent.

But wait, there's more!

While analysts disagree on the magnitude of that income shift, they’d all acknowledge that cranking the top rate up to 90 percent would lead to a massive reduction in taxable income and hence a lot less additional revenue than we found. People facing those high tax rates might work less or hire smart accountants. Either way, reaching our 2 percent deficit goal would require even higher tax rates and would quite likely prove impossible.

In other words, if the government can't get spending under control, they will eventually run out of other people's money.