Tax Analysts Blog

Mind Boggling Tax Hikes on the Horizon

Posted on Feb 25, 2010

The President has issued an executive order that calls for an 18-member bipartisan commission to offer a plan to cut the deficit 3 percent of GDP by 2015. How hard will it be to reach this target?

To answer this question we first need to know to what we are comparing the proposal. In other words, what is our baseline? Unfortunately the official baseline so diligently produced by the CBO is useless because it is required to report the baseline on a “current law” basis. The law as now written excludes a whole bunch of policies everybody expects Congress to approve no matter what. Among the most important of these excluded items, continuation of the Bush tax cuts for families with incomes over $250,000, relief from the individual AMT for tens of millions of taxpayers, and relief for physicians from scheduled Medicare reimbursement cuts.

Recently, two groups have produced realistic policy baselines. One by the Peterson-Pew Commission on Budget Reform (“Red Ink Rising—A Call to Action to Stem the Mounting Federal Debt,” December 2009). And the other by a group affiliated with the National Academy of Sciences called the Committee on the Fiscal Future of the United States (“Choosing the Nation's Fiscal Future,” January 2010).

The baseline from the latter study is shown in the figure. If we continue on our current course, the lowest the deficit ever becomes is 5.6 of GDP in 2013. It rises to 5.9 percent of GDP in 2015 and to 6.8 percent of GDP by 2018. So to get the deficit to 3 percent of GDP the President’s commission must produce a plan that would reduce the deficit by 2.9 percent of GDP in 2015. That will be $523 billion in 2015 ($419 billion in today’s terms). And that’s in a single year.

So how difficult would it be to achieve that goal? Using the best available estimates here are seven possible options:

(1) Raise individual taxes only by 30%
(2) Raise all taxes by 15%
(3) Cut all Medicare, Medicaid, and Social Security by 25%
(4) Cut discretionary spending by 40%
(5) Cut all spending by 13%
(6) (a) Raise all taxes by 8% (b) cut all spending by 7%
(7) Impose of value-added tax of 7.7%

In political terms these are nothing short of earth-shaking. Our gridlocked dysfunctional Congress simply cannot bring itself to absorb these types of painful shocks. They are orders of magnitude away from what is feasible in the current political environment.

By way of historical comparison, the deficit reduction would be almost twice as large as that estimated 1.5 percent of GDP annual reduction from the Omnibus Reconciliation Act of 1990. And back then we had a less polarized political environment with a relatively moderate Republican President on-board for deficit reduction.

As impossible as it all seems, this may be the minimum of what needs to be done. The two bipartisan expert reports cited above are both calling for the federal debt to be targeted to 60 percent of GDP. Under the realistic policy baseline, if the commission reached the goal set by the President, the debt-to-GDP percentage would level out somewhere between 70 and 75 percent of GDP depending on how fast the deficit reduction was phased-in as we approached the target date of 2015.

Given these unprecedented pressures I believe that within the next decade there is more than a 50-50 chance there will be an upheaval either of the political system or the economy.

For more detail see my forthcoming article in the March 1 issue of Tax Notes.

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