Predicting A Need For Higher Taxes

The new report on the US economy by the Organization for Economic Co-Operation and Development says that the American deficit is greater than the government says it is and that one of the results of this is that taxes will need to rise sharply over the next five years.

The report also makes a number of obvious observations  about the importance of efforts to improve greenhouse gas emissions, make government spending more efficient, and create better job training programs for the unemployed.

But, the troubling part of the analysis is that public debt in the US is larger than most believe because federal figures rarely roll in state and local obligations. On that basis, America is deeply in the red. And it means that stimulus spending has great risks because it adds debt upon already unsustainable debt.

The OECD’s conclusion is that the US cannot close its deficits and begin to attack the national debt problem without reliance on higher taxes and a larger tax base. This would include, the organization recommends, smaller deductions for state and local taxes on federal returns and a drop in the amount that homeowners can deduct for mortgage interest. The American government cannot cut expenses quickly enough to close the gap, nor should it. Some amount of extraordinary spending is necessary to bring the economy back on course, and that spending will need to be aggressively offset by revenue.

The usual observation about tax increases whether they are through moving up the tax rate or removing deductions is that they may become regressive. Higher taxes means less spending by consumers and businesses. Lower spending means reduced GDP improvement or even contraction. But, the OECD’s recommendation does point to something that is unavoidable. More taxes will be necessary to reduce the deficit. The government’s ability to tighten its belt or the prudence of belt-tightening both work against an America with a sustainable debt load.

The most important question now is how quickly new taxes can be levied and how the burden will be spread. The OECD analysis shows what most economic models do this. The longer tax increases are delayed, the larger they will have to be and the greater their drag on GDP will be. New taxes, if the OECD is nearly right, would have to begin tomorrow to be most effective.

Douglas A. McIntyre