If we take Speaker Boehner at his word, principle suggests the GOP will rule out raising taxes but not raising “additional revenues.” It then begs the question; ‘What is a tax increase’? In a political arena where the word ‘is’ can be parsed, it’s difficult to say precisely what is and what is not a tax increase.
Any change to the tax code must be viewed through the prism of a baseline. But the question is ‘which baseline’? Under the current policy baseline, revenues to the federal Treasury were 15.7 percent of gross domestic product for the fiscal year that ended September 30. Under this baseline, which reflects today’s tax rates, deductions, the reduction in the payroll tax, and other aspects of the tax code, the Congressional Budget Office (CBO) projects revenues rising to 16.5 percent of GDP by fiscal year 2014.
Then we have the current law baseline which reflects how current tax policy is programmed in law to change automatically over time. Under that baseline, given the scheduled expiration of many of the tax provisions currently in place, total federal revenues are expected to rise to 19.6 percent of GDP by 2014 and 21.4 percent by 2022.
This is where spin comes into play. Efforts to lower the tax share of GDP below the projected level of the “current law” will be branded by Democrats as a tax cut while attempts to increase the tax share above “current policy” projections will be tagged as a tax increase by Republicans. There’s truth in both arguments but neither paints a complete picture.
A good illustration of this is the 12.4 percent Social Security payroll tax, which is levied on nearly all working Americans. Half of the tax is paid by the employer and the other half by the employee. The current policy includes a temporary reduction of two percentage points that workers pay for their portion of the tax this year. But according to the current law, this provision expires on December 31 and workers will resume paying the entire 6.2 percent share of the tax. If this provision expires, as currently planned, is it a tax increase?
There’s broad agreement that increasing marginal income tax rates would constitute a tax increase. This generally holds true when it comes to limiting or abolishing existing deductions and tax credits absent an offset in marginal tax rates as well. But what happens when certain credits or deductions are, in reality, spending programs camouflaged as preferential tax treatment?
We see this with the Earned Income Credit, which lowers federal income tax liabilities for low-income workers. But it is a “refundable” credit; recipients can actually receive benefits that exceed their income tax liability. In truth, the Treasury spends far more money on “refund” checks to Earned Income Credit recipients than it forgoes in tax revenue. Is it a tax increase to reign in a spending program that is embedded in the tax code?
There also are times when less is more. In 2003, Congress lowered the long-term capital gains tax rate to 15 percent from 20 percent, the result being that realized capital gains swelled as investors took advantage of the lower rate. Over a four year period, revenues from capital gains taxes rose to $109 billion in 2006 from only $58 billion in 2002. Even with the lower tax rate, tens of billions of dollars in additional revenue flowed into the Treasury. It has the same net effect of a tax increase but does it constitute one?
This may seem counter-intuitive but it’s valid. Is it a tax increase when changes in tax policy spur growth, leading to additional tax revenue? Granted, not all tax cuts pay for themselves. Most don’t. But any change to the tax code influences behavior. Lower marginal tax rates can create incentives to work, save, and invest, all of which have a positive impact on economic growth. The net result is either smaller-than-expected revenue losses or, in some cases, actual increases in overall revenue.
Higher tax revenues are not necessarily evidence of a tax increase. In focusing exclusively on what constitutes a tax increase, we are distracted from the larger issue; that the income tax system is broken and needs major reform. The more meaningful debate should focus on promoting tax reforms that encourage job creation, investment and savings while also removing provisions that de-incentivize work.
Carter was a deputy assistant secretary of the Treasury under former President George W. Bush and served on the staff of the Senate Budget Committee. Fichtner is senior research fellow at the Mercatus Center at George Mason University and previously served at the Social Security Administration as acting deputy commissioner of Social Security and chief economist.