My previous post dealt with two “surprise” taxes buried in the new Affordable Care Act regulations. And for the past year, observers have been listing the plethora of new taxes scheduled to take affect in 2013, fiscal cliff or no fiscal cliff.
But that isn’t the whole story. Far from it, in fact.
All that you need in order to understand what I’m about to explain, is a little math.
Since the end of WWII, total annual Federal tax revenues have stayed at around 18% – 19% of annual GDP. That includes the years where the top marginal income tax rate exceeded 90% of adjusted gross income. During the same period, the Federal government has spent an average of 18% – 20% of annual GDP. This includes both the Cold War years, where defense spending alone often exceeded 10% of annual GDP, and the post-Great Society years, where entitlement spending routinely exceeded 50% of the total Federal budget.
The result was a rough balance between receipts and outlays, with a manageable annual deficit of around 1% – 2% of annual GDP. But the Obama Administration has significantly altered the former status quo. Federal tax revenue for 2012 is projected to be around $2.47 trillion, or roughly 17% of projected GDP. Meanwhile, Federal spending for 2012 comes in at around $3.7 trillion, or roughly 24% of projected GDP. The Obama Administration originally justified drastically increased spending as a remedy for the ailing post housing bubble economy. But the inflated spending of 2008 – 2009 has become the new budget baseline, with annual Federal government spending projected to rise to $4 trillion and beyond, in the next decade.
Of course this creates an enormous problem – massive annual budget deficits in excess of $1 trillion. We can’t continue to borrow this amount of money indefinitely. The revenue from tax increases already slated for 2013 and beyond will be largely consumed by the Federal government’s take-over of the health care industry. And even if income tax rates are increased for “the rich,” the revenue raised from these increases will be insignificant compared to the size of our projected annual budget deficits.
So how will the government close the massive 5% – 7% gap (relative to GDP) between Federal outlays and receipts? Right now, it seems unlikely that the Federal government will voluntarily reduce spending back to a level that corresponds with 20% of annual GDP. Another option would be solid economic growth that would rapidly expand our annual GDP and reduce the current Federal spending level back to the 20% range. But our current anemic rate of economic growth, combined with Obama Administration rhetoric and policies focused on denigrating and punishing successful investors and businesses, makes such a scenario seem like nothing more than wishful thinking.
The remaining option, and obviously the most appealing route for money and power-hungry government officials, is tax increases. But don’t look for them to be in the form of hikes in traditional income tax rates. The current arguments over income taxes are nothing more than a smoke screen, a distraction that is easy fodder for pundits, bureaucrats, and Facebook meme-spreaders. Right now, behind closed doors, DC power players are planning the real taxation strategy: various cleverly packaged tax increases that will affect all tax payers, and that can be sold to a gullible public through arguments about fairness and equality.
The primary tools for drastically increasing tax revenue will certainly include the elimination of significant existing tax exemptions and deductions. One such item already being targeted is employee health care benefits, which are currently exempted from taxable income:
Workers pay no income or payroll taxes on what their employer contributes for health insurance, and in most cases on their own share of premiums as well.
It’s the single biggest tax break the government allows, outstripping the mortgage interest deduction, the deduction for charitable giving and other better-known benefits. If the value of job-based health insurance were taxed like regular income, it would raise nearly $150 billion in 2013, according to congressional estimates. By comparison, wiping away the mortgage interest deduction would bring in only about $90 billion.
“If you are looking to raise revenue to pay for tax reform, that is the biggest pot of money of all,” said Martin Sullivan, chief economist with Tax Analysts, a nonpartisan publisher of tax information.
Another area of interest involves the IRA, 401(k), and 403(b) tax-deferred retirement savings plans. Pundits have already noted that these plans add a “tax expenditure” to existing tax revenue streams that amounts to around $240 billion per year. A recent study of Denmark’s similar tax-deferred retirement savings plan found that total retirement savings increased by only 1% of the total money given in government tax breaks. Conclusion: these tax deferments are a huge waste of much-needed money. And the class warfare argument is also taking shape. According to the Tax Policy Center, most of the substantial savings available with tax-deferred retirement savings plans are enjoyed only by the top 20% of wage earners.
We should expect to see this issue discussed more frequently in the coming months, with an emphasis restricting or eliminating tax-deferred contributions (particularly for high income earners) or taxing annual growth in retirement accounts as regular income.
There is also another option, favored by an increasing number of DC bureaucrats – abolishing tax deferred retirement plans, and replacing them with a government-managed retirement plan funded by mandatory contributions from all wage-earners. New School for Social Research professor of economics Teresa Ghilarducci has already discussed how such a scheme might work:
If you’re scratching your head right now, you should be. What you just read is a plan to convert real money – your money – into government IOU’s, camouflaged by the notion that you are investing in a kind of government-managed annuity. We should all keep a very close eye on this scheme, because with over $10 trillion currently invested in IRA’s, 401(k)’s, and other tax deferred retirement accounts, the temptation for the Federal government to raid our retirement piggy banks is simply too great.
Finally, we should expect a renewed discussion of the Value Added Tax (VAT). Put simply, the VAT is an incremental tax, levied in stages on a product, based on formulas that derive the amount of “value” added to the product (or its components) at each stage of production. The VAT is figured into the wholesale cost of materials or products at each stage of production, with manufacturers or distributors each paying the tax corresponding to the value that they have added, minus an allowance for the VAT already paid by entities who have previously handled the products or materials. When the product is offered for retail sale, its price reflects the cost of the VAT that has been added. Ideally, VAT rates are adjusted so that the final cost of the product including the VAT will be equivalent to the cost of the same product plus a traditional retail sales tax.
Proponents of the VAT argue that since it has very few exemptions and is calculated in a very straight-forward manner, the VAT is a much simpler and far more lucrative revenue tool than traditional sales or income taxes. But the VAT can only be a preferable alternative to retail sales taxes if it is offered in their place. Would a new Federal VAT replace existing sales taxes? Probably not, since most of our existing sales taxes are levied by state and local governments to help fund their respective costs. Nor would it replace income taxes. Economist Robert Samuelson believes that a Federal VAT simply isn’t feasible without corresponding Federal spending cuts:
Applied to all consumption spending—about 70 percent of GDP—the required VAT rate would equal about 8 percent. But the actual increase might be closer to 16 percent because there would be huge pressures to exempt groceries, rent and housing, health care, education, and charitable groups. Together, they’re nearly half of the $10 trillion of consumer spending. There would also be other upward (and more technical) pressures on the VAT rate.
Does anyone believe that Americans wouldn’t notice 16 percent price increases for cars, televisions, airfares, gasoline—and much more—even if phased in? As for a VAT’s claimed benefits (simplicity, promotion of investment), these depend on a VAT replacing the present complex income tax that discriminates against investment. That’s unlikely; the needed VAT rates would be implausibly steep. Chances are, we’d pay both.
Higher consumer prices from the VAT could also slow the economy. The Federal Reserve would face policy dilemmas. If it tried to prevent businesses from passing the tax along to consumers, it would have to raise interest rates and risk a recession. If it tried to blunt the effect of higher prices on spending, its easy-credit policy might trigger a new wage-price spiral.
… A VAT might be the least bad tax, though my preference is for energy taxes. But what’s wrong with the simplistic VAT advocacy is that it deemphasizes spending cuts. The consequences would be unnecessarily high taxes that would weaken the economy and discriminate against the young. It would become harder for families to raise children. VAT enthusiasts need to answer two questions: What government spending would you cut first? And how high would your VAT rates go?
Even if we succeed in balancing future Federal budgets with additional tax revenues, we will be living in a very different nation; a nation with a vastly expanded Federal government that consumes 25 cents out of every dollar that its economy creates. In other words, a nation with a noticeably diminished private sector, and thanks to ever-increasing regulation, a nation with significantly diminished liberties. Despite the attempts by big-government supporters to dismiss these changes, I believe that an increasing number of Americans will begin to grasp their significance, once they have become noticeably impacted by the government’s encroachment on their lives. The road ahead looks like a very difficult and costly one for the American taxpayer.