Alice Washington in Wonderland

by PETER HUESSY January 1, 2013

As usual Washington is completely obsessed with an issue--to raise or not raise taxes--which will do nothing to control our spending or solve any of the economic problems we face. But the issue has great political import and thus the attention it gets is by Washington standards normal.

Why the mania to raise taxes? Here's the reason. Raising tax rates on those making over $200,000, or couples making $250,000 or those folks making over $400,000 as one compromise suggests, fulfills the Democratic party's long running wet dream: pretending that tax rate reductions for upper bracket Americans caused the 2008-9 downturn in the economy and, as well, budget deficits as far back as the Reagan administration. Technically it does not matter where the cut-off is; the key is simply to raise taxes on someone that can conveniently be defined as "rich", even "millionaires and billionaires".

This will allow them to jump up and down like three-year-olds and pretend since the "rich dragons" have been slain, little more needs to be done to get our fiscal house in order, and all Americans are now safe.

The "deficit dragon" will be dead. The Democrats will be feted like saviors by the drive-by media, and any positive economic news after such a deal will be portrayed as solid evidence that all the ailing economy needed was for the unfair rich to just pay "their fair share". And Washington can continue spending just as it always has--with some notable exceptions-but ever onward giving "stuff", as described by Bill O'Reilly, to the American people. More stuff, more votes.

The question Americans should be asking themselves is to what degree is this a complete and total fairy tale? And just one more con job, putting off the day of reckoning?

Let us look at the numbers.

If top income tax rates go up from 35% to 39.6%, and similarly for the next rate, the revenue from such a tax rate hike as been assumed to come to roughly $44-74 billion a year if the cut off is $200,000 for individuals and $250,000 for couples, depending how the numbers are crunched. [For accuracy sake, it should be noted that Obama Care adds a 0.9 surcharge to this rate on top of the 2.8% Medicare payroll tax that applies to all salaried income, on top of a 1.2% increase due to limits on deductions, so the top rate is really going up to 44.6%.]

The White House has put on its very rosy glasses and claims the new revenue would actually approach $950 billion over the decade, assuming incomes grow steadily over the years as workers deliberately ramp up their incomes in order to pay more taxes! Despite incomes going down over $3500 in the past four years. Some have suggested we increases taxes only on those with income over $500,000, and then the revenue to Uncle Sam would reach $740 billion extra over a decade. This all assumes that taking three-quarters of a trillion out of the private economy, sloshing it around in the Uncle Sam mixing bowl, and then sending it back to both the private and public economy someone, magically, transforms such spending into a stimulus to the economy and not a drag.

That $740 billion revenue increase, for example, represents 1.5 percent of the $39.77 trillion the White House estimates will be collected in taxes over the next 10 years. So we are having a royal political fight with threats of an additional bad economic recession over what amounts to less than 2% of the projected source of revenue for the next decade, while ignoring the critical necessity of dramatically spurring the economic business climate in the right direction to then put to work some 12-23 million unemployed and underemployed Americans--which will produce trillions in new revenue, dwarfing anything being fought over now at the margin.

Right now, the US government is collecting from all sources roughly $2.5 trillion a year; with the income tax rate increase above those making $500,000, the numbers would increase to say $2.6 trillion; and with Obama Care taxes kicking in the revenue is projected to get to $2.7 trillion a year.

But the White House assumes that under their economy--with Obama Care and its ten year $1 trillion in new taxes kicking in, $110 oil per barrel as far as the eye can see, massive new regulations, especially from EPA, adding hundreds of billions in new business costs to the US economy--that somehow the US will generate an average of close to $4.0 trillion in tax revenue every year for the next decade and that there is no negative impact from all these tax increases. The $4 trillion annual haul is 60% more revenue on average than we are collecting now, and that still yields a deficit added to the current national debt of an additional $8.6 trillion over the next decade according to the White House numbers.

So put this in perspective. We are planning on spending $46 trillion over the next decade, increasing spending from $3.8 trillion to a projected $5.3-5 trillion annually. The tax increase which so obsesses the White House might collect $.75 trillion, over that period, maybe, or 1/46th of our total spending during that period, or 8 days of US government spending, or 30 days of one month of government borrowing.

The increase in taxes will probably slow investment and harm business, especially the tax on hospital and health equipment manufacturing. Already firms have stopped hiring or moved overseas. Together the administration is adding $2 trillion in new taxes over a decade to the US economy, (Obama Care taxes and the "tax on the rich") an increase of such magnitude never before added to the tax burden of Americans, on top of which it is being done in what is admittedly a slowly growing economy. The 1990 and 1993 tax deals by comparison raised revenue $50 billion a year.

Much of the pressure to raise tax rates on the rich comes from an enduring fairy tale.

That fairy tale is that tax rate cuts for the rich cause deficits while tax rate cuts for the middle class spur the economy.

On December 28, 2012, the Wall Street Journal carried a news story that was replete with references to this well worn fairy tale. John McKinnon of the Wall Street Journal wrote that "the era of big budget deficits started in 1982, when during the Reagan administration...deep tax cuts led to growing deficits". Additionally, a recent news article said Americans continue to blame Bush for the 2008-9 recession, in part because tax rate cuts for the "rich" lost the US government revenue, and deficits increased. Is this even remotely close to the facts?

The facts, let's look.

The deficits of the early 1980s were caused by 10.8% unemployment, 14% inflation and 21% prime rate bequeathed to the US economy by President Carter. The tax rate cuts did not fully take place until 1983,and they spurred growth from a very bad economy. By 1983, over 4 million new jobs annually were being created, and bringing in over a $100 billion in new revenue each year. Investment in the US economy in 1983 increased by $170+ billion, on a base of $500 billion, and compared to an average increase of $30 billion in the previous three years. And despite tax increases in 1990 and 1993, the deficit for 1995--as McKinnon admits--was $164 billion, compared to $154-7 billion each of the last three years of the Reagan administration.

One excellent analysis concluded: "The Economic Recovery Tax Act of 1981, signed into law under President Reagan reduced several different tax rates. The Heritage Foundation says that 'between 1978 and 1982, the economy grew at a 0.9 percent annual rate in real terms, but from 1983 to 1986 this annual growth rate increased to 4.8 percent.' The Foundation continued, "the unemployment rate, which peaked at 9.7 percent in 1982, began a steady decline, reaching 7.0 percent by 1986 and 5.3 percent when Reagan left office in January 1989' and 'between 1983 and 1986, federal income tax revenue increased by 2.7 percent annually, and total government income tax revenue increased by 3.5 percent annually.'" [See]

So, too, with the tax rate changes in 2001 and 2003.

Stephen Moore in The Wall Street Journal in June 2005 said the following:

"Earlier this month the Congressional Budget Office released its latest report on tax revenue collections. The numbers are an eye-popping vindication of the Laffer Curve and the Bush tax cut's real economic value. Federal tax revenues surged in the first eight months of this fiscal year by $187 billion. This represents a 15.4% rise in federal tax receipts over 2004. Individual and corporate income tax receipts have exploded like a cap let off a geyser, up 30% in the two years since the tax cut. Once again, tax rate cuts have created a virtuous chain reaction of higher economic growth, more jobs, higher corporate profits, and finally more tax receipts."

So while the pending tax increases and spending cuts are nothing more than very bad economics, they were given to us by the White House in 2011, just days before the US might default on its debt. Just as then, the administration seeks to place a gun to the head of its political opponents, but unlike the scene in Blazing Saddles, offers not to shoot itself, but the US economy and the Department of Defense.

There are rules in the Senate and the House for submitting a budget; having hearings in Committee to examine the bill's provisions; marking up a bill; voting on amendments in both Committee and the Senate and House floor; having the will of the House and Senate expressed; and a compromise reached in conference. That is called "regular order", and as Senator Jeff Sessions, the ranking member of the Senate Budget Committee has noted, that is the right way to put a budget, tax policy and entitlement reform together.

Negotiations behind closed doors, in the service primarily of political theater, do not generally reach sound agreements. Former President Clinton recommended we keep the current tax rates where they are for another nine months, until the end of the fiscal year. An agreement to actually reduce government outlays by 1-2% in FY13 through a supplemental spending bill and entitlement reform can substitute for the meat axe approach of sequestration. Then the American people can weigh in with their newly elected members of Congress and get our fiscal house in order, and actually fight the real fiscal dragon that threatens to burn down our collective economy.

Peter R. Huessy is Director for Strategic Deterrent Studies at the Mitchell Institute for Aerospace Studies as well as President of Geostrategic Analysis, a defense consulting firm he founded in 1981. He is also a guest lecturer on nuclear deterrent policy at the U.S. Naval Academy and formerly Senior Fellow in National Security at the American Foreign Policy Council and JINSA.


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