Salvo 07.01.2024 5 minutes

Debt and Taxes

Money falling

Tinkering with tax rates doesn't really change the amount of revenue the government collects.

Does the U.S. government have a revenue problem or a spending problem? The Congressional Budget Office (CBO) released new figures projecting the 2024 deficit to exceed $2 trillion. We’ve run deficits for decades, recently hitting magnitudes not seen since World War II. Our taxation and spending policies are clearly unsustainable. But which one matters more?

Let’s look at American public finances in the postwar era. From 1950 to today, tax revenues as a share of GDP fluctuated between a high of 20 percent and a low of 13 percent. Most of the movement centers around the 17.0 to 17.5 percent range. This is notable because tax policy, specifically marginal tax rates, changed quite a bit during this era.

In the fifties, very high taxes prevailed, with top marginal rates exceeding 90 percent. Then President Kennedy’s tax cut (signed into law after his death by President Johnson) brought rates down to 70 percent in 1964. Though there were no major statutory changes to marginal tax rates in the seventies, persistently high inflation pushed households and businesses into higher tax brackets. President Reagan’s administration saw a significant tax rollback, with top marginal rates falling to 50 percent in 1981, 38.5 percent in 1986, and 28 percent in 1988. Presidents Bush and Clinton increased rates to 31 and 39 percent, respectively. The younger President Bush oversaw a reduction to 35 percent; President Obama an increase to 39 percent; and President Trump a decrease to 37 percent, where it stands today.

Corporate tax rates have also varied significantly over this period. From the fifties through the seventies, the top rate ranged from 53 percent to 48 percent. It started coming down in the eighties, first to 46 percent and eventually to 34 percent. After holding steady at 35 percent from 1993 to 2017, it fell to 21 percent under President Trump. President Biden has proposed increasing it to 28 percent, but this seems unlikely given the Republican Senate majority.

What’s the point of this data dump? The major variation in individual and corporate tax rates over the past 70 years makes the stability of tax revenues all the more remarkable. Given all the tinkering with the amount of money taxpayers must fork over to the government, it’s curious that the amount collected remains fairly consistent, as a percentage of GDP. It looks like there’s a structural economic constraint here. Unless we squeeze very hard, we’re unlikely to generate more than 18 percent of GDP. And unless we become very lax, we’re unlikely to generate less than 15 percent of GDP.

There’s a straightforward economic explanation. When you increase tax rates, you weaken the incentive to do the thing that’s taxed. Higher individual income taxes mean less individual income earned; higher corporate income taxes mean less corporate income earned. Tax rates can get so high that the additional revenue taken in from rate hikes offsets the additional revenue lost from reduced economic activity. The Laffer Curve is real.

This isn’t to say cutting tax rates will always boost tax revenue. I doubt we’re currently on the right side of the Laffer Curve. But this way of looking at tax policy tells us that we can’t expect to generate an arbitrarily large amount of revenue simply by raising rates. Those who believe we can tax our way out of our current difficulties need to double-check their math.

Prudence demands we treat 20 percent of GDP as the upper limit of what Uncle Sam can expect to get out of taxes. Seventeen and a half percent is probably a realistic long-run average. In contrast, spending by the national government has exceeded 20 percent of GDP every year since 2008, and shows no signs of slowing down. The truth is obvious: America has a spending problem, not a taxing problem. Neither theory nor history give us any reason to suppose the problem is revenues.

The politics of perpetual deficits is straightforward. The public likes government spending yet doesn’t like paying for it. But the arithmetic doesn’t care about electability. Americans have gotten all the government they’ve paid for, and plenty more besides. This can’t continue forever, and so it won’t. The only choice is between a turbulent yet ultimately safe landing and a devastating crash. I hope, at least, that self-described conservatives will start taking America’s fiscal imbalance seriously—if only because the risk of the budgetary bomb exploding on their watch is too great to ignore.

The American Mind presents a range of perspectives. Views are writers’ own and do not necessarily represent those of The Claremont Institute.

The American Mind is a publication of the Claremont Institute, a non-profit 501(c)(3) organization, dedicated to restoring the principles of the American Founding to their rightful, preeminent authority in our national life. Interested in supporting our work? Gifts to the Claremont Institute are tax-deductible.

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