The structural mismatch between federal spending and revenue has resulted in a budget deficit starting in fiscal year 2023 of $1.7 trillion, or 6.3% of gross domestic product (GDP). By 2053, the budget deficit is expected to reach 10.0% of GDP.
Therefore, there is no doubt that when it comes to finding solutions to your financial challenges, you need to look at all the tools in your toolbox. A new paper by Brian Riedl of the Manhattan Institute explores how to raise revenue from high-income Americans, how much of the fiscal gap can be closed by “taxing the rich,” and why it takes more money to stabilize the wealth We are considering whether further deficit reduction is necessary beyond taxing groups. national debt.
US revenue
The U.S. tax system is set up to be progressive, meaning the more a household earns, the greater the percentage of taxes it pays. For example, a household in the top 1% of the U.S. income distribution pays an effective federal tax rate of 31.4%, and a household in the bottom 20% is taxed at her effective federal tax rate of 3.8%. At the same time, wealthy taxpayers benefit disproportionately from tax breaks such as deductions, exemptions, and preferential tax rates.
How would taxing the wealthy affect the United States?
As income and wealth inequality increases, many policymakers and experts are calling for higher taxes on wealthy Americans. Definitions of wealthy people often differ. One common category used is households in the top 1% of incomes ($686,100 for her family of two in 2023). Another criterion used is households with incomes above $400,000, which corresponds to the top 2 percent of Americans. The vast majority of proposals to tax the wealthy target personal income taxes, but they could also be taxed through other means, such as capital gains, inheritance taxes, and corporate tax rates.
Riedl considers several categories of income that could be considered a “tax on the wealthy,'' and proposes “maximum sustainable income'' proposals for each. In other words, he proposes the highest amount of income that can be earned from each category without compromising profits. economy. Riedl found that raising personal income taxes on the wealthy would generate the most revenue, estimating that category alone could raise about 1.0 percent of GDP over 10 years.
Other potential sources of new revenue include increases in corporate tax (0.8% of GDP), investment tax (0.2% of GDP), and inheritance tax (0.1% of GDP). Overall, the maximum sustainable return from the proposals analyzed by Mr. Riedl would be to increase his return by a total of 2.1 percent of GDP over the next 10 years. However, Riedl more realistically estimates that number to be in the range of 1.1 to 2.0 percent of GDP, taking into account the macroeconomic response.
This range of savings from “tax the rich” policies is substantial, representing a potential deficit reduction of nearly $7 trillion over 10 years, but alone is insufficient to stabilize debt over the long term. is not enough. Riedl estimates that the interest-free savings needed to stabilize the debt will be at least 5.0% of GDP.
What are other ways to make money?
Given the gap between what is needed to stabilize debt and what Riedl argues is possible through taxing the wealthy, tax policy needs to be targeted more broadly to raise enough revenue. He suggested that the government should either adapt it or introduce new funding sources. For example, the tax credit for employer-paid health insurance premiums is one of the largest tax breaks in the US tax code and represents an untapped source of revenue. Another option for him is to impose a carbon tax, which 46 countries use to both raise revenue and reduce carbon emissions.
Additionally, the introduction of a 20% value added tax (VAT) will also increase revenue. The United States is the only high-income member of the Organization for Economic Co-operation and Development (OECD) that does not have a value-added tax. The absence of VAT is the main reason why OECD countries collect an average of 34.1% of GDP in revenue, while the United States collects 26.6% of GDP. Excluding VAT, OECD countries collect an average of 26.9% of GDP in revenue.
For further savings, Riedl points to spending-cutting programs that benefit higher-income households. 1 trillion over the next 10 years if agricultural subsidies to large agribusinesses are cut and Medicare subsidies and Social Security benefits for retirees with multimillion-dollar net worth (other than housing) are cut. We discovered that dollars could be saved.
Why revenue from taxing the wealthy may be lower than expected
There is no dispute that there is great potential to raise revenue by taxing wealthy individuals and corporations. But Riedl and other experts warn that policymakers need to be aware of the potential macroeconomic implications. Responding to higher tax rates can have the following consequences:
- Change in income: High-income households may shift compensation from wages to tax benefits. This includes moving compensation into lower-tax capital gains and corporate income, offshoring income, and more aggressively tackling tax evasion.
- Short-term response: Those who can afford it may choose to work fewer hours or take more unpaid leave.
- Medium-term response: The second earner or spouse may decide to withdraw from the labor market and instead stay at home (especially if the second person's income pushes the family into a higher tax bracket). Entrepreneurs may also be less likely to create or expand a business because the potential rewards are lower.
- long term response The next generation of workers may shift toward less lucrative college majors and career choices as higher taxes reduce their compensation. Riedl argues that the point is not that tax rates should never rise. However, the broader economic impact of each tax must be considered and traded off against federal spending goals.
Riedl argues that the point is not that tax rates should never rise. However, the broader economic impact of each tax must be considered and traded off against federal spending goals. Reducing the annual economic growth rate by 1.0 percentage point as a percentage of GDP would reduce tax revenues by $3.3 trillion over 10 years.
conclusion
With the federal budget deficit expected to reach 10.0% of GDP in 30 years, Riedl argues that tax increases can and should start with the wealthy, but lawmakers must raise revenue to offset federal spending. They argue that tax increases cannot be relied upon as the only way to increase taxes. Aggressive new tax policies for businesses and the top 1-2% of households could raise revenues by at most 2.1% of GDP, which is meaningful but not enough to stabilize debt. do not have. Riedl's report says lawmakers need to find additional ways to reduce the large federal deficit and that developing smart tax policy is a key to achieving that goal. I'm emphasizing it.
Related: 8 of the biggest tax cuts explained
Image credit: Chip Somodevilla/Getty Images
