- Reason Awakes -

Spending & Taxation; Debt & Deficit Reduction

Introduction

 

This plank of the Platform deals with the critical issues of government spending, taxation, and deficit and debt reduction.


 

The Level of  Spending and Taxation Relative to GDP

 

Background

 

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 about 20% of GDP, in recent years. (State and local government taxes and expenditures represent another, approximately, 20% of GDP.)

 

Despite rising expenditures for Social Security, Medicare, and Medicaid overall federal expenditures were at approximately the same level as federal revenues in the late 1990’s. This was true in large part because of the peace dividend from the end of the Cold War, which led to lower defense expenditures as a percent of GDP.

 

During the Bush administration, as a result of carrying on two wars, federal spending levels were significantly more than government revenues, resulting in federal deficits and a growing national debt. While the Bush era tax cuts are often cited as contributing to the growth of the deficit, they did not materially reduce the level of government revenue below this 20% threshold. The deficit and the national debt began to increase sharply at the end of the Bush administration because of the 2008 financial crisis and various responses to it, like the TARP.

 

In the last few years, federal government spending for all activities, including transfer payments like Social Security, Medicare, and Medicaid, has increased to somewhat more than 25% of GDP, partly as a result of various stimulus programs enacted during the Obama administration. This level of spending resulted in a further ballooning of the federal deficit and the national debt, which now stands at about $15 trillion dollars. 

 

During this entire period 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.

 

At the serious risk of oversimplification, the debate that is currently raging over the budget, the deficit, and the national debt can be sorted out as follows:

 

The Democrats know that in the face of these increasing entitlement costs we cannot sustain the current level of federal spending without crippling debt and potential economic disaster.  They are therefore willing to cut government spending somewhat, but only if the Republicans will agree to increase the share of GDP that is taken in the form of federal taxes and only if these increased taxes come from “the wealthy.”  The Democrats have been a bit vague about who is “wealthy” sometimes talking about “millionaires and billionaires” but making proposals that affect those with incomes of $200,000 or $250,000. 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, would require higher taxes for the middle class, which is where the money is.

 

Republicans have for some time now been tied to a “no net increase in taxes,” pledge.  That has worked well for them as a unifying principle, and they are unlikely to depart from it easily. The Republicans position is that higher taxes will only further reduce economic growth, increase unemployment, lower tax revenues and increase the size of the deficit. The Republicans insist that the way out of the deficit is to reduce government spending levels back to, or below, the levels that prevailed before the Obama administration. The Republicans feel that if we reduce government spending, regulation, and taxation the private sector will grow rapidly, reducing unemployment, increasing GDP and raising tax revenues reducing the deficit and ultimately the national debt.

 

How far government spending should be reduced is a matter of debate within both major political parties. 


Ron Paul, who envisions a United States with a far more modest international presence and a much smaller federal government in general, would like to push federal taxes and expenditures closer to 15% of GDP. Mitt Romney had a target of 20% of GDP for both, or about where we were before the recent increases.  This would seem easy to accomplish were it not for the background drumbeat of rising costs for Social Security, Medicare, and Medicaid.  Holding to 20%, without raising taxes, requires some combination of reducing the rate of growth of the cost of these entitlement programs and significantly lowering the cost of government in general.


The Democrats are much less explicit about what they want. They talk of matching spending cuts with increased tax revenues which leads one to believe that they have a target of about 23% in mind, but that is something of a guess.

 

The Position of the New Independent Party on the Level of Spending and Taxation Relative to GDP

 

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, and Medicaid. 

 

We view this 20% cap on federal spending and taxation as a policy target rather than a legislatively imposed limit, since one congress cannot constitutionally bind a future congress and since getting a constitutional amendment on this issue seems politically impossible.

 

As a side benefit, tying total spending and taxes to GDP would give those who want to see increased government expenditures a stake in seeing the economy grow and in making sure that the government operates efficiently.

 

 

A Proposal for a More Economically Efficient Tax System

 

We believe that the current method for raising tax revenues at the federal level is economically inefficient because it distorts incentives for work, investment and savings. We believe that the Federal Corporate and Personal Income Tax should remain progressive but that rates should be lower across the board. To be precise, we believe that the U.S. tax rates on both personal and corporate income should be at or near the lowest levels in the developed world.

 

We therefore support the following changes:

 

Lower the Corporate Income Tax Rate and Broaden the Base by Simplifying the Code

 

The federal corporate income tax rate should be 20% instead of the current rate of 35%. It should be noted that both major national parties support reducing the U.S. corporate tax rate. The current rate is out of line with corporate tax rates worldwide and puts the U.S. at a competitive disadvantage. The taxation of corporate income is, also, clearly a case of double taxation since this income is subject to taxes again as dividends or capital gains and possibly a third time through the estate tax.

 

We support eliminating as many exemptions, deductions, or credits under the corporate income tax code as possible. Many of these deductions and credits are the result of concentrated lobbying efforts of various special interest groups and corporations. We would, in particular, like to see the end of various kinds of accelerated depreciation and depletion and tax credits favoring specific industries. These special provisions unnecessarily complicate the code, distort incentives for investment, and create incentives for corporations to seek special treatment from Congress. Stripping these provisions out of the tax code and making it harder for new ones to replace them would eliminate much of the motivation for throwing money at political candidates of both parties. 

 

We would also support a territorial corporate tax system, so that global U.S. corporations could repatriate earnings from other countries without having them taxed again in the U.S. Maintaining the current system simply forces these companies to reinvest these earnings elsewhere. Many, if not most, developed countries are already moving in this direction.

 

Lower Personal Income Tax Rates and Broaden the Base by Simplifying the Code.

 

We believe that the top federal personal income tax rate should be 30% rather than the current top rate of 39.6%, with similar reductions in the other marginal rates at lower income levels. The federal capital gains and dividends tax rates should remain at the current levels, with a top rate of 15%. This would create a combined (corporate and personal) top marginal tax rate on corporate income distributed as dividends or capital gains of 32%, which would be slightly higher than the highest marginal tax rate on ordinary income.

 

It is interesting to note that leaving the current corporate tax rate unchanged and taxing dividends and capital gains as ordinary income (as some on the left have suggested) has the effect of making the top marginal federal rate on this income nearly 58%. When combined with the highest state marginal tax rates this would result in an effective marginal tax rate of approximately 62% on this income.

 

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. Similar to the proposed changes in the corporate tax code, 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

 

We support abolishing the Alternative Minimum Tax, which will increasingly begin hitting middle income tax payers, as inflation lowers the real limits on the tax. If the changes we are recommending for corporate and personal income taxes were adopted the original purpose for the tax would disappear. In the absence of significant exemptions, deductions and credits, individuals with significant income would pay significant taxes.

 

Maintain the Current Estate Tax

 

The estate tax represents a form of double and, sometimes, triple taxation. We, nevertheless, support maintaining the Estate Tax at its current levels with exemptions of $5 million ($10 million for a couple), indexed for inflation, and a top marginal rate of 35%.

 

The most economically efficient approach would be to abolish this tax, because so much time and money is wasted attempting to circumvent it. However, we do not believe that abolishing the tax is politically feasible, so the next best alternative is to set relatively high exemptions so most people can ignore the tax. We also believe that settling the issue and indexing the exemptions would provide stability so that estate planning could be conducted without ongoing uncertainty.

 

Add New, Economically Efficient, Sources of Tax Revenue

 

Broadening the base of the tax code, by eliminating exemptions, deductions and credits, will probably not provide enough revenue to offset the revenue lost from the proposed reductions in Corporate and Personal Income Tax rates outlined above. 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 these 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 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, gambling, pollution (possibly even “green house gases”), sweetened drinks that contribute to obesity, and a broad based tax on oil consumption described in the section on "Energy Policy."

 

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.

 

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. These 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 these institutions up.

 

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 should be fully self-supporting such as the Post Office, the Patent Office, and the Food and Drug Administration. 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.

 

What We Would Not do in Terms of Federal Taxation

 

No Hidden Taxes

 

We believe that the federal government should not transfer taxation to the state level by expanding unfunded mandates for state spending. We would, also, oppose "implicit taxes," such as requiring employers to provide benefits to employees, without the money ever showing up in the federal treasury.

 

No National Sales Tax or Value Added Tax

 

We would oppose the use of a national sales tax or value added tax because they reduce the progressivity of the tax system to no good end. Consumption is not a bad thing. It is, in fact, the ultimate purpose of all economic activity.

 

We Would Not Eliminate the Earned Income Tax Credit, the Personal Exemption or the Standard Deduction.

 

For reasons that will be explained later related to maintaining the progressivity of the tax code we would retain the Earned Income Tax Credit, the Personal Exemption and the Standard Deduction. It would be our expectation that the changes described above would result in far more people using the Standard Deduction.

 

We Would Not Propose a Flat Tax

 

The Flat Tax, sometimes called the Fair Tax, is an intriguing idea. It would be far simpler to administer and more economically efficient than even our own plan. Unfortunately, it would have the effect of significantly increasing the after tax income of the very wealthy. We view this as politically unachievable regardless of its merits.

 

Tax Priorities

 

If sufficient revenue cannot be raised by broadening the base of the tax code and adding the new sources of tax revenue outlined above to achieve all of the targeted reductions in tax rates, we recommend proceeding with the corporate income tax rate reductions first. A reduction in corporate tax rates is required to maintain the competitiveness of U.S. firms and has been proposed by both major parties.

 

Debt and Deficit Reduction

 

The growing national debt threatens future economic growth and the ability of the government to adapt to changing economic and national security emergencies.  It also threatens the ability of our government to provide services such as Social Security and Medicare that individuals have been led to believe they can depend upon.

 

The Need for Gradual Action to Start Soon

 

The debt and deficit problems can best be solved slowly, but that can only be done if we begin to solve the problem in the near future. Therefore we favor a policy of gradual deficit reduction so that we can begin to get the problem under control as quickly as possible, and thereby avoid draconian changes in public policy later on.

 

Proposals for Reducing the Deficit and, Eventually, Reducing the National Debt

 

We agree with the Republicans, that higher taxes on work, investment, and savings would be counterproductive at this time. We believe that by broadening the base and simplifying both the corporate and personal tax codes we can lower these tax rates and provide incentives for investment, work and savings that will spur economic growth and reduce the deficit.

 

Unfortunately, this will not be enough to begin reducing our national debt. We therefore have proposals for curtailing the rate of growth in entitlement spending (see Social Security and Health Care), for reducing spending in most other areas of the federal budget, and for raising tax revenues in ways that don’t distort the incentives for work, investment, and saving. 

 

 

Is the new tax system fair?

 

The changes to income taxes outlined above will lower income taxes on the middle class, upper middle class and the wealthy. 

 

The new, economically efficient, sources of tax revenue listed above would shift the burden of taxes away from wages, savings and investing and toward those in society who through their decisions impose burdens on the rest of society.

 

We think this approach has, at least, an equal claim with "progressivity" for being ethical. 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. The overwhelming majority of taxes will still be collected from the upper-middle and upper income groups. Is it less “progressive” than the existing system? Probably. But the fairness of a tax system should not be judged solely by its degree of progressivity. 

 

The small loss of progressivity associate with this approach also serves a larger purpose. We belive 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.




Go to the Next Plank

Express Your Opinion!
Tell us how you feel about the issue addressed on this page: