Apr 18, 2017 - 9:30am

Tax Reform Could Be An Answer To The Fiscal Nightmare Left By Obama


Vice President, Economic Policy Division, and Chief Economist

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U.S President Barack Obama shake hands with President-elect Donald Trump during the 58th presidential inauguration. Photographer: Saul Loeb/Pool via Bloomberg
U.S President Barack Obama shake hands with President-elect Donald Trump during the 58th presidential inauguration. Photographer: Saul Loeb/Pool via Bloomberg

The Congressional Budget Office (CBO) recently released its annual nail-biting review of the nation’s fiscal future under current policy.  Bottom line – it still stinks.  U.S. fiscal policies in the aggregate are by any measure simply unsustainable. Budget deficits approaching $600 billion this year will soon soar to $1.4 trillion and beyond.

Because these figures are so enormous, describing the deficits as shares of the economy as measured by Gross Domestic Product (GDP) is more convenient and arguably more relevant. As a share of GDP, the deficit in 2017 will be a barely sustainable 2.9%, rising to a wholly unsustainable 5.0% by the end of the decade, and then climbing inexorable to a thoroughly outrageous 8.6% in about 30 years. Herb Stein once aptly described the reality: If something can’t go on forever, it won’t. The fiscal future CBO outlines cannot go on forever. Sure as sunrise, fundamental changes to spending and possibly to tax levels are coming, and probably sooner than most politicians would like.

This wretched fiscal future appears despite the fact federal taxes as a share of GDP, at 17.8% already substantially exceeding the modern average of 17%, are projected to climb to 19.3% and beyond. The driver of rising deficits and debt is, no surprise, mandatory spending which most policymakers don’t want to touch. But touch they will and soon as first the Medicare Part A Trust Fund depletes in about 10 years, and then the Social Security Trust Fund follows soon behind.

In addition to documenting the dismal fiscal future left by the Obama Administration, CBO also almost inadvertently makes two compelling cases for pro-growth, comprehensive tax reform.

The CBO’s Case for Tax Reform

Working past the frightening fiscal picture, one finds in the CBO report two strong motivations for comprehensive tax reform.  The first case for tax reform appears in Table 5 of the report showing the projected rise over time in effective marginal tax rates on labor and capital income, duplicated below.

Effective Marginal Tax Federal Tax Rates Under CBO’s Extended Baseline

 201720272047
Marginal Tax Rate on Labor Income29.8%31.1%32.9%
Marginal Tax Rate on Capital Income15.5%18.1%19.1%
Source: Congressional Budget Office

 

The story these figures tell is a simple one. If the current tax code is left in place, effective marginal tax rates on labor and capital income will rise steadily. One may argue with CBO’s methodology and therefore the absolute levels, but the trend line is sure to be much the same using an alternative methodology, leaving the basic point that rising effective marginal tax rates will pose an increasing burden on economic growth going forward. The solution is a pro-growth tax reform that lowers and stabilizes these effective tax rates going forward.

This leads naturally into the second argument for comprehensive tax reform implied in the CBO report. While fundamental fiscal policy changes are certain, with sustained, stronger economic growth, policymakers will have much more discretion about the magnitude and timing of these changes. Comprehensive tax reform and regulatory cost reductions can trigger that.

Stronger growth is obviously necessary and important for improving Americans’ economic security and prosperity.  However, stronger growth would reduce the growth in federal outlays and would more substantively increase future federal tax receipts, both effects working to slow the growth of federal deficits and debt going forward.  President Trump and Congress will have a handful of prime opportunities this year to address both the anti-growth aspects of federal tax policy and the unsustainable trajectory of federal debt and deficits.  They ought not waste a single one of those opportunities.

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About the Author

About the Author

Vice President, Economic Policy Division, and Chief Economist

Dr. J.D. Foster is vice president, Economic Policy Division, and chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.