In the days since the election, large deficits and the upcoming threat of a "fiscal cliff" have renewed the Democrats' call to raise taxes on the rich. This is not new. What is new is the Republicans' willingness to entertain the idea. Unfortunately, this sudden convergence of interests allows both sides to focus on taxes and avoid talking about what they should really be doing: cutting spending.
To be sure, the tax code is a mess. Tax liability actually has little to do with how much one makes, but has much more to do with whether one lives in a high or low tax state, has kids, or rents or owns a house. These loopholes have made the tax code complex and unfair. Also, rates are too high. Finally, it discourages savings investments by double taxing them. It should be reformed.
This is what reform should look like: get rid of all tax deductions and lower the marginal tax rate. In an ideal word, there would be one rate and it would be relatively low so as to minimize the harm to economic growth.
This is what it shouldn't look like: changes that only target one category of taxpayers, whether it is by capping their deductions or letting their tax rates go up. If Congress is going to raise taxes, it should raise taxes on everyone.
First, targeted tax increases won't put a significant dent in the deficit. There simply aren't enough rich people. According to the Congressional Budget Office, letting the rich go over the cliff would generate less than $950 billion over 10 years. The cumulative deficit over that period will be more than $6 trillion. An additional tax on the rich, such as Warren Buffett's millionaire tax, would raise $47 billion (at best) over 10 years. Even if you are in favor of higher taxes on the rich, you have to admit that this won't go far toward solving any problems.
Second, under the current tax regime, the federal government has never been able to consistently raise more than 19 percent of GDP in taxes, despite the drastic historical fluctuation in tax rates on the wealthiest Americans. From 1930 to 2012, tax-revenue collection in the United States has never topped 20.9 percent of GDP. And it only stayed at that level for one year. The average tax collection over that period is only 16.5 percent of GDP.
Should we target the rich because they pay less in taxes than the middle class? If it were true, then yes, but it isn't true. Over at CNBC, Robert Frank pointed to data from the IRS showing that millionaires pay a rate that's nearly three to four times the rate paid by the middle class. But that shouldn't surprise us, since the federal tax system is extremely progressive compared with that of other countries.
Finally, as we know, there is often a big difference between who is targeted by a given tax and who actually pays that tax, so anyone calling for an increase in taxes should be careful. In this case, I would go further. No matter how much one thinks we should soak the rich, there is a real chance that the burden resulting from higher taxes on the wealthy will fall on many people making a lot less money than Warren Buffett does.
Washington has a dramatic bipartisan spending addiction that won't go away if Congress focuses on revenue instead. Politicians may want to continue kicking the can down the road by using rich taxpayers as scapegoats, but if they don't treat their addiction now, we will need to raise everyone's taxes far and beyond their current levels later.