Want to take politics out of deficit reduction? Then eschew tax hikes

There’s a lot of talk in our nation’s capital these days about putting aside politics and coming together to reduce the federal deficit. To this economist, that sounds good. Unfortunately, some of the people saying its time to drop the politics are either disingenuous or simply don’t understand the economics at work.

As a quick review, let’s remember that federal outlays have leaped from $2.73 trillion in the 2007 fiscal year to an expected $3.82 trillion in fiscal year 2011 — a breathtaking jump of 40 percent. Along with this unprecedented rise in spending has come an unprecedented rise in the federal deficit, going from $160.7 billion in 2007 and climbing to an expected $1.65 trillion this year. That means federal debt held by the public went from $5.03 trillion in FY 2007 to an estimated $10.86 trillion for this year — an increase of 116 percent.

At the same time, one of the deepest and longest recessions and subsequent under-performing recovery meant that federal revenues took a hit, falling from $2.57 trillion in FY2007 to a projected $2.17 trillion this year.

It’s crucial to understand that the fall in revenue is all about the bad economy. Get the economy back on a solid path of economic growth and government revenues will rise accordingly.

This brings us back, then, to the best way to wrestle the federal deficit and debt monster to the ground.

Tax increases have two major problems. First, higher taxes drain resources from the private sector and, in the case of higher income and capital gains taxes, reduce pro-growth incentives for entrepreneurship and investment. Those are clear negatives for economic growth, with government revenues commensurately restrained. Second, emphasizing tax increases as all or part of the deficit “solution” shifts the focus off the ultimate problem, which is the astounding increase in government spending over the past few years.

In effect, including tax hikes in any effort to reduce the deficit will only fuel further increases in government spending. That is the exact problem, from an economic standpoint, with the current level of federal deficits and debt, namely, that they will lead to higher taxes.
The economically sound path to reducing federal deficits and debt is to cap spending as a share of the economy, and then prioritize spending accordingly.

U.S. Rep. Jack Kingston, R-Ga., has submitted a bill to cap federal spending at 18 percent of gross domestic product, the broad measure of goods and services produced in the country.

TheHill.com quoted Kingston as saying the measure “creates a box that the government has to operate within … that’s the best way to illustrate it: You set the confinements, the boundaries; we’re not talking about what’s in that box … but whatever you can fit inside that box is fine — but the box is only so big and over the next five years continues to shrink over time until you get down to 18 percent.” Regarding proposed caps at higher levels of GDP, Kingston said, “If you shoot for 20 percent, then you are building in deficits, and we want to eliminate the deficit.”

By the way, an 18 percent cap would put spending as a share of the economy roughly at where it was at the end of the Clinton administration.

In a recent Wall Street Journal story on various efforts and negotiations proceeding to curb the deficit, it was noted, “For his part, Senate Minority Leader Mitch McConnell, R- Ky., like other Republicans, has repeatedly insisted that the GOP would brook no tax increases as part of a budget deal.” Those favoring bigger government and higher taxes to feed federal spending accuse

Sen. McConnell and others making such no-tax-increase declarations of playing politics. Actually, just the opposite is the case. Those seeking to suck more resources away from the private marketplace driven by economics to spend more resources for political purposes are, well, by definition, playing politics.

Yes, indeed, let’s push the politics out of the budget debate.

Raymond Keating
Raymond Keating




Raymond Keating is chief economist for the Small Business & Entrepreneurship Council. Reach him through the Web site at www.sbecouncil.org.