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Home Publications Blogs Beat the Press Dealing With the Budget Deficit: Does the Middle Class Have to Take the Hit?

Dealing With the Budget Deficit: Does the Middle Class Have to Take the Hit?

Sunday, 13 November 2011 08:42

Adam Davidson has a piece in the NYT magazine about how the middle class will have to take a hit to deal with the country’s deficit. It’s a bit quick to reach this conclusion.  

First, the piece too quickly dismisses the possibility of getting substantial additional tax revenue from the wealthy. It presents the income share for those earning more than $1 million as $700 billion, saying that if we increase the tax rate on this group by 10 percentage points (from roughly 30 percent to 40 percent), then this yields just $70 billion a year.

However, if we lower our bar slightly and look to the top 1 percent of households, with adjusted gross incomes of more than $400,000, and update the data to 2012 (from 2009), then we get adjusted gross income for this group of more than $1.4 trillion. Increasing the tax take on this group by 10 percentage points nets us $140 billion a year. If the income of the top 1 percent keeps pace with the projected growth of the economy over the decade, this scenario would get us more than $1.7 trillion over the course of the decade, before counting interest savings. Of course there would be some supply response, so we would collect less revenue than these straight line calculations imply, but it is possible to get a very long way towards whatever budget target we have by increasing taxes on the wealthy.

There are also other ways to address much of the shortfall. In the case of defense, the baseline projects that military spending will average 4 percent of GDP over the next decade. We had been spending 3 percent of GDP on defense in 2000, and the share had been projected to drop further over the course of the decade. If military spending averaged 3 percent of GDP over the next decade, that would save us $2 trillion before interest savings. There are reasons that people may not want to go that low (also reasons to go lower:  CATO used to advocate a budget about half this size), and it may take time to reduce Defense Department budgets, but it should not be absurd to imagine that we could get by with the same sort of military budget (relative to our economy) that we actually had a decade ago.

Another way in which we could have substantial savings that would be relatively painless is to have the Fed simply keep the bonds that it has purchased as part of its various quantitative easing operations. It currently holds around $3 trillion in bonds. The interest on these bonds is paid to the Fed and then refunded to the Treasury. Last year it refunded close to $80 billion in interest. The projections show that the Fed will sell off these bonds over the next few years so that these interest earnings will fall sharply. However, if it continued to hold the assets, over the course of a decade it could save the government around $800 billion in interest payments. The Fed might have to take other measures to contain inflation (the immediate reason for selling the assets would ostensibly be to raise interest rates and slow the economy), but it has other tools to accomplish this goal, most obviously raising reserve requirements. (The Chinese central bank uses reserve requirements as a main tool for controlling inflation.)

Finally, the big story in any serious discussion of the long-term budget is health care. We pay twice as much per person as people do in other wealthy countries. Since more than half of the tab for our health care is paid by the government, our broken health care system becomes a budget problem. If we paid the same amount per person for our health care as people in other wealthy countries, we would be looking at long-term budget surpluses rather than deficits. The reason that we pay so much more is not that we get better outcomes – we don’t generally. Rather it is that we pay too much to drug companies, hospitals, medical specialists, and others in the health care industry.

We can’t keep on this course on either the public or private side. The real question is whether we look to save money by having people get fewer services or we look to save money by paying providers less. The former could mean, for example, giving seniors a Medicare voucher that we know will not be sufficient to cover the cost of care for most people. In this case, they will just have to do without some amount of care.

The other route involves restructuring the health care system. This is incredibly difficult politically as was seen in the debate over President Obama's health care plan. Nonetheless, in the long-run serious reform is the only option, since the alternative is that large numbers of people (including very middle class people) will not be able to get decent care.

One route to get around the political obstacles is to rely on trade. (Here is a short piece I wrote on trade in health care with Jagdeesh Baghwati.) If we make it easy for people to go abroad for health care and open our doors to qualified foreign doctors, we will eventually be able to undermine the ability of the providers’ lobbies to block reform.

Even before trade has much impact on the structure of the health care industry there are enormous opportunities for large budget savings in health care costs that focus on reducing payments to providers (e.g. lower prescription drug prices in Medicare). These payment cuts would not in any obvious way lead to reduced services.

In short, there is little reason to be talking about imposing increased burdens on the middle class any time soon. For the near term, the budget deficit is clearly not a problem. The financial markets are willing to lend the country large amounts of money at very low rates. Over a longer term, the deficit will pose more of an issue, but most of this pressure will come from health care costs. If these costs can be contained, and we get additional revenue from the top 1 percent and restrain the military budget, then the need for the middle class to bear additional burdens can be pushed out well into the future.

At some point, we likely will need more revenue from the middle class since we will probably want to increase government spending in some areas like infrastructure, education, and research and development. However, this is not a near-term prospect and quite possibly not even something that will be necessary over the course of a decade. Furthermore, if the need for additional revenue comes at a time when the unemployment rate is again down in a 4-5 percent range and real wages are rising, it will be much easier for the middle class to bear.

Comments (22)Add Comment
written by liberal, November 13, 2011 8:33
...saying that if we increase the tax rate on this group by 10 percentage points (from roughly 30 percent to 40 percent)...

This is idiotic to the point of being seriously uninformed. (Yeah, I know, Dean is only quoting this.)

The truly filthy rich make much of their money on capital gains; they don't pay 30%.

The best tax reform right now would be to treat capital gains just like other income.
In The Long Run The Middle Class is Dead, Low-rated comment [Show]
written by fuller schmidt, November 13, 2011 8:46
Increased burden on the middle class is just code for "they need to be paid less". And while our wage and benefit structure needs to be optimized, you'll never find a "manager" who thinks he or she is overpaid. Plus they aren't thinking through income inequality and a third-world style of living in their futures. It also seems like physicians have nowhere else to move to if the US brings their pay in line with the rest of the world.
written by skeptonomist, November 13, 2011 9:33
Davidson claims that the general opinion among economists is that corporations should be taxed less. If true this would be a bizarre opinion for Keynesian economists, because corporations obviously have plenty of money now which they are not using. The idea that corporations are not investing now because tax rates are too high is laughable. It would probably be a good thing if there were a temporary confiscatory tax on corporate profits, the money to be spent on public works.

Economists actually do seem to have bizarre ideas about the incentive role of taxes - many seem to assume dogmatically that the lower the tax rates the greater the incentive to invest usefully. Human psychology is actually considerably more complex than the quasi-linear models of economists - they make little effort to actually determine motivations, or even to take account of historical evidence (e.g. the fact that the US performed best economically when tax rates were high and highly progressive).
Percent of GDP
written by Edward Allen, November 13, 2011 9:52
Thanks for this excellent post.

One suggestion: It's time to stop speaking about military spending as a percentage of GDP. This frame serves the interests of the MIC, unintentionally on the part of progressives.

The fact is that if $NNN billion is what's needed for an adequate DOD, then that's the amount needed regardless of any rise in GDP, correcting for inflation.

Absolute, not relative, figures are the appropriate measure. (Of course, times change and the absolute figure may require adjustment--up or down.)
written by bmz, November 13, 2011 11:49
The US can reduce its deficit fairly easily because our income taxes are far too low. From 1945 to 1980 income taxes averaged near 12% of GDP. Reagan reduced marginal tax rates so much that they fell close to 9%. Clinton increase them back to 12%; and Bush/Obama reduced them again to 9 %(and below). However, on budget expenses have remained 12%(+/-1%)) of normalized GDP throughout(except for the Reagan/Bush1 years, when they were higher) . The deficit in income taxes has been financed by borrowing, largely from the Social Security trust fund. But, not only can we no longer continue to borrow from the trust funds, we have to start paying money back as beneficiaries start relying on the trust funds. In the short term, we have to raise income taxes to 12%, simply to cover on budget expenses. In the long term, income taxes must rise above 12% in order to pay back the trust funds. What do you say Ann/Karl?
The pain is real, the bubble is false
written by Union Member, November 13, 2011 1:16
In short, there is little reason to be talking about imposing increased burdens on the middle class any time soon. For the near term, the budget deficit is clearly not a problem

Isn't the word "austerity" functioning as the term "bubble" does in that it is an imagined perception of wealth; but differing in that, rather than exaggerating and expanding perceived wealth, it is its reverse, a vacuum, inducing exhaustion of wealth (And always, it seems, at the expense of the public sector)?

Isn't the use of the term "austerity" stretching for a political solution to what is an economic trap? (Sprung by the private sector, who when they cause trouble for themselves get rescued by the public sector. In graduate school for Economics or Finance is "austerity" ever studied? In the English Departments it would be called the Dickensian Model)

There is much welcome talk in the media regarding the upward distribution of income and how it has become ever more extreme in recent years. There needs to be more reporting, like this post, about how the pain is - and in evermore extreme ways - being distributed downward. Especially since, as Europe is foreshadowing, the real pain resulting from the Housing Bubble - and its evil spawn the Financial Crisis - is just beginning.
Top 1% pay 30%?
written by david smith, November 13, 2011 3:17
Data I found shows $1MM+ income paying 22.8% in 2007 (not sure why no later data). http://www.ritholtz.com/blog/2...-business/
Higher marginal rates
written by tom, November 13, 2011 3:25
We could increase the marginal rate to 40% on the top 1%, and also another 10% on income over $1 million, and say another 10% on income over $3 mil and another 10% on income over $10 mil, for a marginal rate of 70% on the highest income. (I would also suggest a marginal rate of 90% on income over $30 mil, but this wouldn't bring in much money, it would just persuade the ultra rich to invest more in their businesses and plunder less.)
Getting the message across
written by Julian, November 13, 2011 8:14
I always like the clarity and consistency of your arguments Dean. When will people start paying attention? The main stream media and politicians seem to be willfully ignorant of the alternative scenarios you present. I just read a piece in the current issue of "The Economist" which as is its usual style argues for a what they claim is a middle-of-the-road position - namely accepting we need some tax increases but at the same time conceding we will need to cut benefits such as SS and medical care. How come these supposedly more serious journals make no attempt to even consider the arguments that you offer? I'd love to see a real debate about these ideas instead of the tired platitudes I keep reading and hearing about elsewhere. You, Reich, Krugman, and Stiglitz all provide a great service yet I get the feeling many of our politicians and much of the MSM are all living on another planet in refusing to even acknowledge that there are sensible alternatives to the disastrous course we seem hell bent on following.
Overseas health obstacles
written by Nassim Sabba, November 13, 2011 9:14
I think the is a problem with a foreigner just buying into a different country's system. Or at least I feel that would be the case. Please correct my misperception if that is not the case.

Like in the US, public healthcare in most advanced countries is supported by the current generation. Anyone who benefits from such a system has already supported the generation before him.

So, if someone new just show up and pays the small amount that same age citizens of that country pay currently is not equal to them. Current citizens have already paid their dues to the system, but a new comer has not. It is like having built a social equity.

Thus any new comer who will not be a citizen may have to pay much higher.

As a test, I have written the health minister in Quebec twice, asking what would be the downpayment equivalent (present value) of what I would have paid in to the system in the past, and then what would be my "premium" from then on.

Obviously the minister didn't respond, taking me for a cooke. Non the less, I believe such a calculation may have to be effected.

I would like to see an accurate analysis. Even without insurance today it is cheaper to go to eastern europe for super high quality dental work at less than half the cost here. I imagine medicine will be even more competitive.

A friend who had an emergency spinal operation in Iran three years ago astounded her doctor here in Boston as to the quality and efficacy of the service she had received for $18,000 or so. It would have had cost her (or the system) about $76,000 here, not including followup care.

If that quality of care is available in what we consider as third world, what can we get in Europe or the far east.

But buying into such system doesn't seem to be a simple walk-in arithmetic.
Marginal Tax - Too Big to Be Fun
written by Nassim Sabba, November 13, 2011 9:26
I wish to understand the human reaction to increases in marginal taxes.

Would the Beatles stop singing if the marginal tax was 70%, Bill Gates stop working, or Steve Jobs? Very doubtful. If so, someone else would fill the vacuum. Creative people will not stop. The country runs on creativity, which is usually not the middle management. The nose-picking management types are those who oppose taxes. Their self esteem is defined by their take-home pay.
A soap advertiser's self respect is also his take home pay. But a creative person's self worth goes beyond pay at some point.
Management types seems to be trying to kill middle class, not real business entrepreneurs.
So, why should we not ram an 80% marginal rate after your reach $18 million?
"The Economist" is Fox News for the pretentious
written by Joe Emersberger, November 13, 2011 11:23
Seems to me that you expect way too much from "The Eccnomist". I stopped reading them yers ago after concluding that, despite the generally serious writing style and wide variety of topics covered, they are not very informative or insightful at all. They proclaimed, for example, that "only fools or knaves" could doubt that Saddam Hussein had WMD just prior to the 2003 invasion. On economic issues they similarly cling tenaciously to the basic dogmas that the rich and powerful believe and offer inconsequential critique.

You'll neeed to go to blogs like Dean's to find knowledgeable and uncomprimised analysis.
Upper marginal tax rate
written by MarkJ, November 14, 2011 6:58
Empirical data suggest (http://www.angrybearblog.com/2...ld-be.html) that the "sweet spot" for an upper marginal tax rate is about 65%. An upper marginal tax rate less than 65% and growth suffers.
It's Not Just the 1%
written by Steve Abramson, November 14, 2011 7:33
When you imagine a fair and simple tax system, it is not only about targeting those who can most afford to pay, which we should do. We should also consider which recommended change would bring about the maximum positive growth for the economy and domestic employment. Growing GDP and jobs at a faster rate will reduce the need for higher tax rates.

For the promise of maximum growth one should look to the benefits to be gained by replacing the Corporate Income Tax with a Value Added Tax.

Only the VAT is approved under GATT rules as border-adjustable to eliminate the cost of government from competing international goods and services. The VAT is added to imports and subtracted from exports. All U.S. trading partners and over 150 countries employ a VAT to our competitive disadvantage.

Replacing the CIT by a VAT would eliminate the double-taxation of dividends and make the U.S. (with zero CIT) a magnet for foreign investment. U.S. multi-nationals would have the incentive to bring capital home from overseas deposits of profits in lower-taxed countries.

The VAT is much more difficult to avoid than the CIT, and would force many companies which currently do avoid the CIT to contribute to our cost of government.

Gov. Mitch Daniels envisioned sweeping tax reform by replacing the current code with a zero-preference (loopholes) VAT balanced by a Flat Personal Income Tax with a high threshold and zero deductions. The lowest quintiles would be protected from the VAT via the Earned Income Tax Credit. Earned and unearned income would be treated equally.

That plan should be designed as a revenue-neutral plan, and "scored" for distribution of burden, and adjusted for fairness. Then, after the expected initial positive effect on growth is measured, the percentages on the consumption and income tax bases can be tweaked to bring about a balanced budget over a period of years.

FYI, the VAT is now supported by Pres. Clinton, Warren Buffett, Wilbur Ross, Bloomberg.com, AARP (Jim Toedtman), Ezekiel Emanuel, David Stockman, Bruce Bartlett, Jeffrey Sachs, William Gale, Sen. Domenici, Sen. Hollings, Alice Rivlin, Christina Romer, Andy Stern, Richard Trumka, and others. (BTW, both the "999" and FlatTax plans have VAT components, but they are not border-adjustable under GATT rules.)

Steve Abramon
VATinfo.org (website resource for Value Added Tax)
Just DoD spending?
written by LSTB, November 14, 2011 8:14
Sure Defense gets a lot of money, but we should also pay attention to government spending on other redundant military-related bureaucracies, such as the numerous intelligence agencies and the Department of Homeland Security. They don't provide much value ("Orange Alert"?) and they cost much.

Also, land value taxation would probably benefit society at the expense of the rich too. At least, that's what Henry George and Adam Smith thought.
Flat Tax Switch and Bait
written by MarkJ, November 14, 2011 9:06
There is some chatter about a flat tax proposal but few details on the effects of a flat tax for most of us. VATInfo.org seems to be a mouthpiece of the "let's scare everyone by talking about today's deficit" crowd than a resource for honest tax debate.
Tax to balance
written by Nassim Sabba, November 14, 2011 11:11
How about a balanced tax tied inversely to the growth rate of the economy.

If wealth trickles down, and the economy is weak, those up above are not letting it trickle. So, we can help them do that with a tax that varies inversely with the growth rate of the economy, up to a 100% rate.

If the economy stalls (0 growth) then we KNOW that the tricklers have failed and we take 100% of their income and feed the economy until it starts again.

This way, there should be no problem with the Trickster's Trickle Hustle.
for pete's sake
written by joe, November 14, 2011 12:15
"For the near term, the budget deficit is clearly not a problem. The financial markets are willing to lend the country large amounts of money at very low rates."

The US govt does NOT need to borrow money. Think about it, money had to exist before you could borrow it. We have a non-convertible currency in a floating exchange rate system. Get used to it. When you have a printing press, your debt is no longer true debt and your borrowing is no longer true borrowing. Even Dean admits that the federal govt is at no risk of not being able to meet its obligation. You just gotta think through all the logical implications of this.

Oh yeah, the deficits puts downward pressure on interest rates by creating excess reserves.
Marginal Tax Rates
written by Ethan, November 14, 2011 12:44
Nassim Sabba and MarkJ
For the past 50 +/- years I have wondered why people fear higher marginal tax rates. Remember, during the Eisenhower years, when we had a really booming economy, the highest marginal rate was 90%+.

We are told high marginal rates discourage people from working harder and being more productive/profitable. I would think just the opposite. If I can keep only half of the next dollar, I will try to earn another $2 so I can still take home the extra dollar.

I have a similar problem with the manager who says you need to pay me more if you want me to do my best. Do you mean you're not doing your best now?

You guys have helped me understand.
Monetary Sovereignty
written by Rodger Malcolm Mitchell, November 14, 2011 4:18
GDP = Government Spending + Private Investment + Private Consumption + Net exports

So tell me again, how does reducing government spending grow the economy ??

Those who do not understand Monetary Sovereignty (http://rodgermmitchell.wordpre...economics/) do not understand economics.

Rodger Malcolm Mitchell
written by Charles Yaker, November 14, 2011 5:10
It is a shame that so many so called Progressive Economists do not understand how Fiat currency works and therefore buy into the entire false deficit meme. Read Mosler http://www.moslereconomics.com

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.