Friday, January 16, 2009

The Coming Really Big Tax Increase

I have written before that the government generally spends a little less than 20 percent of GDP and if left unchecked Medicare, Medicaid and Social Security will take 20 percent of GDP all by themselves by 2050. Recently, government spending has exploded with all the bailouts, the assumption of Freddie and Fannie and the TARP money. Some observers say we are moving toward Federal spending of around 22 percent of GDP and if we add Obama's universal health care we will be at 27 percent. The question that the politicians never address is "how are we going to pay for it?" It is too much to assume that the government can finance these expenditures through borrowings. First, the market will become saturated, government borrowing costs will rise and crowding out will occur as rates also increase for private investment resulting in lower borrowings by businesses and consumers. Indeed, more government borrowings to finance ever increasing spending dooms the economy to slower business investment and slower economic growth. Second, the Fed can monetize the national debt - like it has been doing recently - by buying Treasurys and agency securities. This, of course is purely inflationary which will ultimately add to our economic woes. Third, the government can raise taxes. This, too, forebodes economic disaster. Higher taxes means less consumer spending and less business investment. The question is what type of taxes and on whom? Given that nearly 50 percent of all wage earners do not pay Federal income taxes, it would political suicide to start imposing taxes upon them. For the 50 percent who do pay taxes, forcing them to shoulder the load of $700 billion more would result in increased tax avoidance, a mass exodus, a revolt or both. More than likely, the new taxes will have to be in the form of a consumption tax. This is a hidden tax which will be assessed on all purchases of final goods and services. The resulting driving up of prices will lower real income and decrease the quantity of goods and services demanded. The end result will be lower wealth, less investment, and a poorer citizenry. It is very likely that government spending and taxing will cause my grandchildren to be the first American generation that is poorer than the previous one. Today more and more businesses are relocating their headquarters out of the country to avoid ever increasing burdens of regulation and taxation. However, unlike within the states when people  can move to another state, there are no other country where I would rather live. So I guess I can take some comfort in being 63 because by the time all this occurs I should be dead.


Anonymous said...

Perhaps the government can follow President Obama's example and "tamp" down the spending? Isn't bait and switch in vogue?

David J. Moore, Ph.D. said...

Taxes is always a big issue in politics. At the core is a simple question: is the government better at spending the fruits of production or the citizenry? It can be argued that both are equally bad.

Often, the countries without taxes (UAE) come up as a "model." What is left out of the conversation is the UAE has oil wealth to pay for police, hospitals, fire departments, etc. In the absence of a highly demanded finite supply commodity to export daily we will need SOME taxes. The question is how much?

Someone suggested to me that bailing out GM and Chrysler will be ineffective because their taxes are too high. Looking at the last 4 or 5 years of data as a quick check, Toyota (and Honda) actually paid more taxes when measured as a percentage of sales. Another observation is the taxes paid by Toyota and Honda are on the order of 3.5% and steady year after year.

So why not have a simple corporate flat-tax of 3.5% (with no deductions of any kind) and save the IRS and our corporations all the headache? I suspect the answer is, in so doing people do not get to complain about a high _marginal_ tax rate.

My point is, any study regarding profitability and taxes with _marginal_ tax rates on the righthand side is misleading at best in the presence of deductions and loopholes. Also, raising the marginal tax rate, as you pointed out, will only lead to more circumvention tactics.

Flat-tax and people will quit complaining about high taxes even though they actual check mailed to the government will be higher! :)

Appleton said...

whats your thought about lowering/resetting the federal minimum wage alongside tax cuts?

Appleton said...

Circumvention - definitely. The simple case study would be to count all the moving vans from NY to CT.