Banking & Finance and Opinion and Taxes and Economic Analysis and Government

Hicks: Raising taxes won't increase federal revenue

April 30, 2011

It should now be abundantly clear to all that spending—and the promise of more spending—has so long exceeded federal tax revenue and the promise of future federal tax revenue that a crisis is at hand.

In Congress, there is only one proposal that is not bereft of actionable detail. It calls for historic spending cuts and widespread changes to social programs much akin to those that successfully reformed welfare in 1996. This plan, offered by Republican congressman Paul Ryan, includes no tax increases. He need not have bothered, for Congress suffers no shortage of meretricious proposals for tax hikes. It is in spending restraint in which Congress suffers famine. However, it does beg a question: Could we reasonably raise taxes to help reduce the deficit, and what would those tax increases look like? Here’s an insider’s guide to raising taxes.

At the federal level, tinkering with tax rates will have little effect. Hauser’s Law, which is really an empirical observation, notes that U.S. income tax revenue has hovered within a percentage point of 19 percent of our total economy for more than 50 years. This was a time of many changes in tax codes. We could raise or lower rates, but without economic growth, we could not reasonably boost tax revenue.

There is another approach that was too briefly mentioned by President Obama in his budget speech. It is fundamental tax reform. In his defense, he could not talk about it much as it has been a longtime goal of many in the GOP, and most tax economists.

Fundamental tax reform is possible under two circumstances. First, we must give up the mirage that it is costless to craft social policy through the tax code. Either our tax system exists to fund government, or it exists to promote the policy de jure, not both. Second, we can no longer view the tax system as a tool for redistributing income.

To raise more tax revenue, tax reform will require widespread elimination of deductions for households and businesses. We might be able to keep home mortgage deductions or depreciation of capital expenses, but must dispense with such folly as credits for buying an electric car or a tax break to drill for oil. We must also harmonize corporate and income tax rates so as to stop sending our corporations to Europe.

Reform can also include raising the payroll tax to cover all income derived from work. It must also broaden the base. Not half of households, but all Americans, should bear some tax burden, even if it is a dollar. None of this alone will actually raise revenue significantly, though (remember Hauser’s Law). To increase revenue, we have to also lower rates for all these taxes and grow the economy.

We can raise tax revenue, but it means an end of special deals for friends of Congress and no more demonizing the rich. This will lead to anguished paroxysms of disappointment to many, but it is the price of more government services.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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