Home > Business Cycles, Deficit Commission, Fiscal Cliff, Fiscal Policy, Recession, Taxation > Tax Rates and the The Fiscal Cliff

Tax Rates and the The Fiscal Cliff

The public has been deluged with reporting about the “fiscal cliff” and I admit to some concerns about my contributing to this barrage of information. But while there has been, as usual, lots of reporting about the business cycle effects of the fiscal cliff, I have seen little systematic analysis of exactly what will happen without action by the federal government.

The Tax Policy Center of the Urban Institute and the Brookings Institution has provided what appears to me to be the most thorough analysis of what will happen to tax rates if the federal government does not act. The complete analysis is Toppling-off-the-fiscal-cliff but this is likely to be overkill for most readers. To simplify, I have extracted Tax-Tables-Toppling-off-the-Fiscal-Cliff from the report so that readers can see the effect of federal inaction on personal income tax rates. You will note that nearly every tax bracket will rise by about ten percent. And note that these are marginal tax rates which are the tax rates that affect economic incentives. Thus the returns to saving, investment, and labor supply will go down for nearly every taxpayer.

In addition, the Tax Policy Center report notes that there will be additional tax increases associated with estate taxes, Social Security, the Alternative Minimum Tax, and Obamacare (and this is not an exhaustive list of all tax increases that will occur) so that 90 percent of all taxpayers will see an increase of some sort in their tax bills. What will be the consequences of these increase in tax rates? There will likely be a recession next year and real output will fall permanently (see my previous post on this subject). But there is a larger issue underlying all of this.

The President has stressed raising tax rates on the rich. There are estimates in the media that he wants an increase in tax rates that would generate about $80 Billion in additional tax revenue. In the first month of the federal government’s fiscal year, the federal government deficit was $120 Billion. So even if the tax revenue forecast is accurate (and it is almost certainly an overestimate), the tax increases favored by the President will not cover even one month of the federal government’s deficit. This illustrates the magnitude of the financial problems that we face as a nation.

The public must realize that, without entitlement reform, the entitlements promised by the federal government will require higher tax payments by all taxpayers if we are to avoid insolvency. It is simply delusional to think that a tax increase on the rich will solve our financial problems. Is the public ready to pay more? Your guess is as good as mine.

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Economics One

A blog by John B. Taylor

The Grumpy Economist

One economist's views on economic policy.

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