Tax levels cheat sheet

Tax levels cheat sheet

Here is your tax levels cheat sheet.

  • Over the past 50 years federal taxes have averaged 18% of GDP.
  • Governor Romney proposes taxes “between 18 and 19 percent” of GDP.
  • The House-passed (“Ryan”) budget proposes long-term taxes of 19% of GDP.
  • President Obama’s budget proposes long-term taxes at 20% of GDP.*
  • The Bowles-Simpson plan proposes long-term taxes at 21% of GDP.

See how nicely that works?  18-19-20-21

There is a danger that measuring tax levels as shares of GDP will lead to casually concluding that “only one or two percentage points difference” is not a big deal. This would be a huge mistake.

  • GDP this year will be about $15.5 T. That means each 1% of GDP in higher taxes is about $155 B more taken by the government from those who earn it.
  • Going from 19% of GDP to 20% of GDP means a total increase of all federal taxes of just more than 5% (20-19 / 19 = 5.26%)
  • For comparison, the ongoing partisan fight over whether to extend today’s tax rates for “the rich” is a fight about half a percent of GDP. The difference between the Ryan and Obama long-term tax levels is twice as big, and the difference between the Ryan and Bowles-Simpson plans is four times as big. Also, the legislative difficulty of closing these gaps is not linear, meaning it is more than twice as hard to close a gap that is twice as large, because policymakers make the easiest changes first.

I intend this rule-of-thumb to be useful for medium-term and long-term fiscal policy discussions, not  for short-term debates. Federal taxes are pro-cyclical, meaning that when the economy is weak, taxes as a share of GDP drops. Taxes/GDP is quite low right now, but that’s in part because the economy is still quite weak. The above numbers are what each policymaker has proposed for their long-term tax share of GDP, measured 5-10 years from now.  In each case they would start with taxes lower than their long-term share. Taxes/GDP would then gradually climb through the next ten years, stabilizing at the rates specified above.

I put an asterisk after the Obama line. The Ryan and Bowles-Simpson plans would stabilize debt/GDP in the long run, while President Obama’s would not. Since President Obama has not proposed a long-term fiscal policy solution, we don’t know whether his long-term fiscal solution, if he had one, would raise taxes above 20% of GDP.

Few seem to have noticed that Messrs. Bowles and Simpson have proposed long-term taxes that are significantly higher than those proposed by President Obama. The spending component of the Bowles-Simpson plan is between the House-passed (Ryan) plan and the President’s proposal, but it’s much closer to and shaped like the Ryan plan. I think that’s consistent with the political dialogue surrounding it, which sees Bowles-Simpson as a middle ground between the two parties.

But on taxes the Bowles-Simpson plan represents one end of the spectrum, not a middle ground, at least until (if) President Obama proposes a long-term fiscal solution. The tax component of the Bowles-Simpson plan is the highest (“leftmost”) of the three, at least for now. This provokes an interesting question for any elected official, of either party, who says he or she supports the Bowles-Simpson recommendations: “So, as part of a long-term fiscal solution, you’re OK with total tax levels five percent higher than those proposed by President Obama?”

Our long-term fiscal problems are immense, and some elected officials may knowingly choose these big tax increases as part of a package combining spending cuts and tax increases. I wonder, however, if some elected officials who have been attracted by the bipartisanship and centrist optics surrounding the Bowles-Simpson effort understand what they are supporting on tax levels. It would be a shame to unwittingly embrace such a massive tax increase.

(photo credit: David Stillman)

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