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Thursday, July 08, 2010

Do Tax Rates Need to Go Up?

I should emphasize that this is a discussion about what needs to happen after the economy recovers, not what we should do right now:

Taxes Need to Come Up, But That Doesn’t Mean Tax Rates Have To, Diane Lim Rogers: ...[A] really old point (or maybe three points) I’ve made over and over again...:

  1. We need more tax revenue;
  2. the current-law baseline is a good “role model” for the right level of revenue; but…
  3. sticking to current-law baseline revenue levels doesn’t require sticking to current tax law, and doesn’t even require seeing marginal tax rates go up.

...one way to achieve a more sustainable outlook as far as the revenue side of the budget goes is to just let current tax law happen – and avoid passing any new tax legislation, including any extension of any of the Bush tax cuts.  ...

The CBO long-term budget outlook shows us that sticking to current-law baseline revenue levels is a good and fairly immediate strategy for fiscal sustainability (where debt/GDP is relatively stable, staying below 80 percent over the next 25 years).  ...

But ... current tax law is probably not the best way to raise the current-law level of revenues. Put this challenge to any tax economist:  how can we raise that given level of revenue most efficiently? – and you will get the answer that we need to find the marginal (new) sources of revenue from the broadest, most neutral/efficient tax bases available to us. There are two main possibilities here, and I think we ought to seize both possibilities:

  1. reform the existing federal income tax system to clean up and broaden the income tax base–e.g., close up inefficient tax expenditures that “poke holes” in the income tax base (the many exclusions/exemptions, deductions, and credits); or
  2. add on “cleaner” (broader, purer, or externality-correcting) new tax bases–e.g., an add-on value-added tax (VAT) or environmentally-motivated taxes such as a carbon tax.

With these sorts of base-broadening strategies to achieve current-law revenue levels, marginal tax rates on productive economic activities don’t have to come up. ...

One tax that isn't mentioned, one I go hot and cold on, is a financial transactions tax. It would raise quite a bit of revenue, and its effect on efficiency appears to be minor (though that claim is the part that causes me to hesitate). Dean Baker is a proponent of this type of a tax, and he argues the tax will actually be  efficiency-enhancing.

A carbon tax is also tempting as a source of revenue -- such a tax (or its equivalent) is needed to correct externalities and enhance efficiency -- but I think the revenue will need to be used to compensate the people and businesses hurt by the legislation. This is partly because some people, e.g. low income households, will need to be compensated for the higher energy costs they'll face (here's a graphical illustration of how this works).

But it's also because legislators will likely demand payoffs to individuals and businesses affected by the legislation (even those causing the carbon emissions in some cases). Many of these individuals and businesses are key sources of campaign contributions, and payoffs will be required to obtain support for the legislation. Thus, I'm not counting on a carbon tax as a significant source of revenue (supposing it could even be enacted, which is a big suppose).

I've been reluctant to even talk about long-run issues because I think we ought to be focused on our immediate problems -- the job market comes to mind -- and this is a distraction. Worse, it can be counterproductive since an increase rather than a decrease in the deficit is needed in the short-run. So let me add once again that this is for another day. Right now the economy needs more help, and cutting the deficit will make things worse, not better.

    Posted by on Thursday, July 8, 2010 at 01:17 AM in Budget Deficit, Economics, Taxes | Permalink  Comments (96)


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