Taxation, Spending, and Debt

Summary

This policy position deals with the critical issues of government spending, taxation, and debt. We recommend targeting the long-term ratio of federal government spending to GDP to around 20%. We recognize that existing commitments, associated with the baby-boom generation, will mean that this ratio will rise above these levels for a period of time. We recommend an efficient method of taxation, compatible with our other policy objectives, to limit the extent to which the current bubble of entitlement spending adds to the deficit.

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Background

The Level of  Spending and Taxation Relative to GDP

In order to have a sensible discussion about the appropriate level of government spending and taxes, we need to define terms and lay out some history.

All federal government revenues, including taxes for Social Security and Medicare, have run around 17% of Gross Domestic Product (GDP), in recent years. GDP is the total value of all the finished goods and services produced within a country.  

Net total federal outlays have run about 20% of GDP in recent years, peaking at 25% and 30% of GDP during the 2008 and 2020 recessions respectively.

State and local government expenditures represent another, approximately, 17% of GDP. State and local expenditures and revenues tend to be equal, because they are generally required to balance their budgets.

Over the last few decades, the costs of Social Security, Medicare, and Medicaid have been steadily rising absolutely and as a percent of GDP. Given current demographic trends and increasing costs for medical care in general, everyone agrees that if we don’t do something, these programs will consume an ever-larger share of GDP. The Congressional Budget Office forecasts that these expenditures (Social Security, Medicare, and Medicaid) will rise from around 10% of GDP in 2009 to around 16% in 2035 and 25% of GDP in 2082.

The Policy Debate

At the serious risk of oversimplification, the political debate over the deficit can be sorted out as follows:  

The Democrats

Democrats used to be willing (e.g. the bi-partisan Simpson-Bowles proposals) to cut government spending somewhat, but only if the Republicans would agree to increase federal taxes and only if those increased taxes came from “the wealthy” and corporations.  

The Democrats have been a bit vague about who is “wealthy,” sometimes talking about “millionaires and billionaires.” As a factual matter, significant increases in revenues cannot come from taxing only “millionaires and billionaires,” we don’t have enough of them. Sustaining anything like the current size of the government, without making material changes in the entitlement programs or running up dangerously high levels of national debt, would require higher taxes for the middle class, which is where the money is.

Democrats often say that they can raise these funds by taxing the rich and corporations. Increased taxes on corporations, which the Democrats advocate, will have impacts on individuals across all income levels, through their effects on the value of IRAs/401Ks, employee’s jobs and wages, and consumer prices.

Most of the Democratic presidential candidates in 2020 seemed to have either no concern for the economic impact of higher deficits or believe that they can “soak the rich” to pay for their various government benefits such as free medicare for all, free college education, free child care and college loan forgiveness, to name just a few.

The Republicans

The Republicans (e.g. Simpson-Bowles) used to favor reducing the deficit by reducing government expenditures but were willing to match them with some increase in government revenues.

The Republicans now argue that if we reduce regulation and taxation, the private sector will grow rapidly, reducing unemployment, increasing GDP and raising tax revenues, thus reducing the deficit and ultimately the national debt. These “supply-side” effects of reduced taxation, though real, are too small to actually increase net revenues.

Both parties appear to have abandoned any support for reducing government spending.   

The Position of CIVPAC on the Level of Spending and Taxation Relative to GDP

Why Tie Spending and Taxation to GDP?

The ratio of spending and taxation to GDP is a very rough measure of the degree of socialism within an economy. An economy in which the ratio is 100% is purely socialist (none has ever existed). An economy in which the ratio is zero is a purely free market economy (no large one has ever existed). The U.S., with total government expenditures around 40% of GDP, is a mixed economy. As a general rule, the larger the share of expenditures represented by the government, the less efficient (and therefore poorer) the economy.

Our Target

We support a long-run target level of federal taxes and spending, including entitlement programs, at about 20% of GDP. This is roughly the level that prevailed prior to the 2008 economic crisis, but it is a challenging target, nonetheless, because of the projected rapid growth of spending for entitlement programs like Social Security, Medicare, Medicaid and the ACA (ObamaCare).  If we add on the entitlement programs being proposed by the Biden administration, this target is clearly unachievable.

We recognize that with no change in entitlements, and other programs maintained at current levels, federal spending will reach about 35% of GDP by the middle of the century, just based on current demographics. Our hope is that we can find a way of controlling the per capita cost of these entitlement programs so that, when the baby boom generation passes, federal government spending levels can revert to around 20% of GDP.  

Note this does not mean that we can never have any new social welfare programs. In fact, we favor several in the areas of education and health care. What it does mean is that we will need to pay for those programs by increasing economic growth, cutting other programs, or by raising taxes in a manner than does not limit economic growth by discouraging work, savings, and investment. If we adopt these more efficient forms of taxation, we would support a long-term target for federal outlays of around 25% of GDP.

A Proposal for a More Economically Efficient Tax System

We believe that the U.S. tax system should remain progressive. However, in order to remain competitive, U.S. tax rates on both personal and corporate income should be at or near the lowest levels in the developed world. As a consequence, if we want to increase federal government revenue in order to reduce the deficit or pay for new social welfare programs, we must look to new sources.

Broaden the Base by Simplifying the Code

We would support the elimination, or reduction, of as many tax exemptions, deductions, and credits as possible. This includes eliminating or scaling back the deductions for home mortgage interest and charitable deductions. Simplification of the personal income tax code will lower the cost of tax compliance and reduce the incentive for interest groups to attempt to influence the political process to get favors written into the code.  

Abolish the Alternative Minimum Tax (AMT) 

We support abolishing the Alternative Minimum Tax. If the changes we are recommending for personal income taxes were adopted, the original purpose for the AMT (to make sure that everyone with significant income pay significant taxes) would disappear. In the absence of significant exemptions, deductions, and credits, individuals with significant income would pay significant taxes.  

Allow the Current Estate Tax Rules to Expire in 2025 and Index the New Limits to Inflation

The estate tax represents a form of double and, sometimes, triple taxation. The tax law changes in 2018 raised the exemption to $11.2 million for an an individual and $22.4 million for a couple. This change expires in 2025 and the estate tax reverts to exemptions of $5 million ($10 million for a couple), indexed for inflation, and a top marginal rate of 35%. We support allowing the 2018 changes in the estate tax to expire in 2025. 

Add New, Economically Efficient, Sources of Tax Revenue   

Broadening the base of the tax code, by eliminating exemptions, deductions, and credits will not provide enough revenue to offset the expected impact of rising expenditures for existing entitlement programs. We, therefore, propose three additional sources of tax revenue. The common theme of these proposed taxes is that those who impose costs on society should compensate society through taxes that reflect those costs.  In some sense these taxes are economically ideal because, by definition, they do not inefficiently distort incentives for economic activity. In fact, they create incentives for individuals and firms to act in a way that reflects societies best interests.  

Externality (Sin) Taxes  

It is, in general, a good idea to tax things that you would like to discourage rather than things you would like to encourage. As a consequence, we support so called “sin” taxes on cigarettes, alcohol, pollution, and green house gases.   The term “sin tax” should not be taken to imply a moral judgment. The correct economic term is an externality tax. Externalities are said to exist when one person’s consumption of a good or service imposes costs (or benefits) on others, not directly involved in the transaction. Pollution is the classic example.  Our proposals include a $50/ton carbon tax and a matching tariff on carbon content. This is, by far, the largest revenue raiser of these proposals.

Too Big to Fail Tax

Analogously, we believe it makes sense to impose a tax on large financial institutions. The level of this tax should be a function of the scale of the company and it should be inversely related to the company’s financial reserves. Large financial institutions could avoid the tax entirely by breaking themselves up or by de-leveraging. These companies would have to choose between reducing the “too big to fail” burden that they impose on the rest of society through size and leverage, or compensating society for it. We believe this is a better approach than regulatory intervention to break up these institutions.   

User Fees

We also support the increased use of user fees such as highway tolls, entrance fees to national parks, and fees for other government services. We believe that many government bureaucracies, such as the Post Office, the Patent Office, and the Food and Drug Administration, should be fully self-supporting. Such fees, where practicable, place the financial burden of government services directly on the primary beneficiaries. These fees should never be more than the cost of providing these services, since they are meant to recover the costs of these services and not to discourage their use.  

Is the new tax system fair?

The new, economically efficient, sources of tax revenue listed above would shift the relative burden of taxes away from wages, savings, and investments, toward those in society who, through their decisions, impose burdens on the rest of society.   We think this approach is at least as ethical as a progressive tax (taking proportionately more from the rich). For example, if society is going to take up the burden of subsidizing medical care for all citizens (see the Health Care section), society has a vested interest in the health habits of its citizens and therefore has the right, perhaps even an obligation, to tax bad health habits.

Similarly, if scale and leverage make it more likely that taxpayers will have to rescue failing financial institutions, it is only reasonable that these institutions should be taxed in proportion to the degree they impose this burden on society.  

Also, a more extensive use of user fees will place the burden of government services more directly on the primary beneficiaries. This, too, seems only fair.  

Is this system regressive?

Absolutely not. A regressive tax system would take proportionately more from lower income people. The overwhelming majority of taxes are currently collected from the upper-middle income and upper income groups. This will still be the case if we add the proposed taxes described above. Is it less “progressive” than the existing system? Possibly. But the fairness of a tax system should not be judged solely by its degree of progressivity. The possible small loss of progressivity associated with this approach also serves a larger purpose.

We believe it is unwise to have a tax system in which any group of citizens pays little or nothing for government services. Such a system only encourages those groups, wholly insulated from the costs of government, to prefer too much of it and those groups paying a disproportionate share of the cost to prefer too little of it.  The proposed system will ensure that everyone, or nearly everyone, pays at least some of the burden of running the federal government, either directly or indirectly. As a consequence, we are more likely to get to a meeting of the minds as a society on the appropriate role of the federal government in our lives. 

For those who believe that any reduction in progressivity is unacceptable, the economically efficient way to restore progressivity to the system, after adding these new taxes, would be to create a Guaranteed Basic Income. For more information on our view on this issue see the Guaranteed Basic Income Proposal.

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