The dramatic economic decline due to the Covid-19 crisis and the unprecedented recovery spending plans approved by President Trump will drive the fiscal 2020 United States budget deficit to a record $3.8 trillion, or 18.7% of U.S. gross domestic product, according to the Committee for a Responsible Federal Budget (CRFB). According to the same estimates, the fiscal 2021 deficit would reach $2.1 trillion in 2021, and average $1.3 trillion through 2025 as the economy recovers from the impact of the forced shutdowns.
To finance this staggering fiscal effort, the Democratic Party leader, Joe Biden, is announcing a massive tax hike that will neither help the economy nor reduce the deficit.
The solution to the United States budget deficit is not more taxes. Even in the most optimistic receipt scenario, there is no tax hike program that would even start to address the structural deficit, estimated at one trillion dollars a year, even less with the above-mentioned estimates.
More taxes will hurt the recovery, damage the job improvement potential, and reduce investment in the economy. More taxes mean less growth and no deficit improvement.
The Obama administration learnt this lesson quickly, and extended the Bush tax cuts in 2020, adding a new tax cut in 2013. Other United States misguided tax hikes in 2013 did nothing to reduce the debt and kept the economic and job growth below potential.
A wealth tax, often repeated by the most extreme politicians in America, would not only provide exceedingly small revenues for the Treasury, it would generate more negatives than any improvement in tax receipts. There is a reason why almost every European nation has abandoned the wealth tax. The receipts are negligible and the negative impact on investment, attraction of capital and job creation outweigh any revenue increase. The wealth tax revenue relative to GDP in the countries where it exists range between 0.07% in Finland to 0.22% in France. There is no way that a wealth tax would collect 1.4% of GDP as Senator Warren estimated. A wealth tax in the United States would make no visible reduction in the existing deficit, let alone finance the trillions in entitlement spending that Biden has announced.
So, how can the United States reduce the deficit?
US deficit is rising due to excessive spending increases, despite periods of rising tax receipts. The federal government’s revenue went up by 4%, to $3.46 trillion in the 2019 fiscal year, according to the Congressional Budget Office (CBO) report. However, spending went up by more than 8%, to $4.45 trillion.
The rise in 2019 deficit was not due to the “tax cuts”. If anything, the tax cuts helped the economy stay in expansion, creating jobs and increasing receipts at the same time. Corporate income taxes increased by $25 billion (+12%), while individual income and payroll taxes together rose by $107 billion (+4%). Overall, total receipts rose by 4% ($3,462 billion in the fiscal year 2019). Total receipts remained at 16.15% of GDP, which is the long-term trend figure and consistent with an economy that remained in expansion with moderate growth.
The main problem is that total outlays rose by 8% (to $4,446 billion), driven mostly by mandatory expenses in Social Security, Medicare, and Medicaid.
Those that say that the deficit would have been solved eliminating the Trump tax cuts have a problem with mathematics. There is no way in which any form of revenue measure would have covered a $338 billion spending increase.
No serious economist can believe that keeping uncompetitive tax rates well above the average of the OECD would have generated more receipts. Furthermore, no serious economist can believe that eliminating the Trump tax cuts would have generated more than $300 billion of new and additional revenues.
Remember that corporate tax receipts already fell 1% in 2017 and 13% in 2016, before the Trump tax cuts. The operating profit recession was already evident. If anything, reducing the corporate rate helped companies recover, which in turn made total fiscal revenues rise by $13 billion to $3,328 billion in the fiscal year 2018, according to CBO.
The problem of the United States budget is Mandatory Spending.
Mandatory spending was $2 trillion out of a total of $4.45 trillion outlays in fiscal year 2019. This figure is projected to increase to $3.3 trillion. Even if discretionary spending stays flat, total outlays are estimated to increase significantly above any advance in tax revenues.
Printing money has not reduced deficits or debt. The Federal Reserve has increased its balance sheet to record-highs, on its way to $10 trillion, and purchasing Treasuries has only driven governments to continue to spend above budget and the trend of receipts.
Furthermore, if proponents of massive money printing tell us that deficits do not matter and that the United States government should spend all it needs because the Fed will acquire all the debt, then there is no need for higher taxes, is there? In fact, if Modern Monetary Theory (MMT) proponents were right, taxes should be cut, and deficits monetized to drive the recovery.
The problem is that the magic money tree does not exist. Monetary policy is only disguising a structural and dangerous spending problem and this reckless behaviour can only be maintained if the US dollar remains the world reserve currency. Therefore, not only there is a limit to how much can the Fed print, there is also a risk that if governments do not reduce spending, the US may lose its world reserve currency status.
Consequently, the only solution for America to reduce debt is to cut spending and entitlements.
Any politician should understand that it is simply impossible to collect an additional $3 trillion per year over and above the existing receipts. They should also understand that the trust in the US dollar may collapse if deficits continue to balloon.
It is completely impossible to double the receipts of a growth year like 2019 with higher taxes. Higher taxes will only wreck an already weak economy and delay the recovery. It is completely impossible to reduce deficits printing money. Governments will only increase spending if they can monetize it at the expense of real wages and savings.
Believing that the deficit can be reduced by massively hiking taxes is not understanding the US economy and the global situation. It would lead to job destruction, corporate relocation to other countries and lower investment. Believing that the deficit will be reduced printing money is not understanding the perverse incentives of governments.
The proof that the US problem is a spending issue is that even those who propose massive tax hikes are not expecting to meaningfully cut the deficit, even less so reduce the debt, that is why they add massive money printing to their magic solutions. It will not work either. And this reckless policy may destroy the US dollar’s reserve status.
Debt matters, even if interest rates are low. Increasing debt and spending means lower growth and weaker real wages in the future.
People always lump social security, medicare, and medicaid together as entitlement spending, but the problem is that the increase in the rate of spending is very different. It’s almost all medicare. Plus various disability benefits which are largely fraudulent, signed off by doctors. Plus subsidizing the ridiculous pharma costs. In other words, it all comes down to medical stuff.
But it’s not actually the costs being incurred. The medical sector is a huge racket ripping off people who are in no position to defend themselves.
$25B in tax revenue on a $20T economy.
What specific mandatory spending cuts and reforms do you recommend? Everyone says cut SS, Medicare and Medicaid but they never are willing to say how much and where. Any cuts in those 3 will simply transfer the costs of those services to other means whether it be states, cities, churches, charities, etc. You can’t simply cut SS and just expect recipients to eat less. Cuts in the medical programs will lead to more indigent care at hospitals. How will they absorb that cost? People who need medical care are going to get it one way or another.
The answer for USA to reduce these excessive deficits is to introduce the European style Federal Value Added Tax (VAT). It has more benefits other then raising taxes at source. GDP USA say $20Tn. BUT Annual consumer spending in USA reached approximately 13.41 trillion U.S. dollars.
Assuming 50% is food and zero rated items, let’s say we have a budget approx $5Tn to tax at 20% (av EU rate) thus we can raise $1Tn annually which would make a big dent in the deficit. Not sure what the overall economic effects would be, but it works in Europe and UK.
“If anything, the tax cuts helped the economy stay in expansion, creating jobs and increasing receipts at the same time.”
I have come to a point where I completely reject this line of reasoning. If we reduce the taxes, say, to corporations to zero, but do not simultaneously reduce unproductive expenditures (what you are specifically referring to) by the same amount ceteris paribus there is no present value positive impact on the economy. Somebody still needs to pay the bills.
If the corporations accepted bonds in place of their receipts for taxes paid, they are richer and the public sector poorer, net zero. But (still) having just paid the government bills as they have been doing, they have no additional resources at their disposal. They receive interest income, the government has interest expense, net zero. Depending on how the corporations allocate that interest income and what the government must necessarily reduce from its budget, there will only be a very minor shift in the allocation of resources, but no “growth”.
Sure, no serious economist can believe that keeping uncompetitive tax (collection) rates well above the average of the OECD (Organisation for Economic Co-operation and Development) will generate more receipts, but in real terms on a present value basis without freeing up unproductive government expenditures (to be reallocated) we simply drive up the cost of the existing resources.
I am specifying unproductive, non-self-liquidating, expenditures but even productive, self-liquidating, government investments must necessarily compete with private sector initiatives.
“To finance this staggering fiscal effort, the Democratic Party leader, Joe Biden, is announcing a massive tax hike that will neither help the economy nor reduce the deficit.”
Neither massive tax (collection) hikes, nor massive tax (collection) cuts, grow the economy. ONLY and ever does the economy grow through productive activities. Tax collections only redistribute what is produced.