The Ultimate Flaw in Obamanomics

Fixing entitlements through ever higher taxes would kill the economy.

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How does Barack Obama want to make Social Security solvent? By raising taxes—specifically by removing the wage cap on Social Security taxes. No talk of cutting spending. What if we applied that high-tax philosophical approach toward entitlement spending in general, paying for the projected rise in spending for entitlements—from 18 percent of gross domestic product to 35 percent in 2082—by higher taxes with no cuts in spending? The good folks at the Congressional Budget Office did the scary math (bold is mine):

With no economic feedbacks taken into account and under an assumption that raising marginal tax rates was the only mechanism used to balance the budget, tax rates would have to more than double. The tax rate for the lowest tax bracket would have to be increased from 10 percent to 25 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 63 percent; and the tax rate of the highest bracket would have to be raised from 35 percent to 88 percent. The top corporate income tax rate would also increase from 35 percent to 88 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. Revenues would probably fall significantly short of the amount needed to finance the growth of spending; therefore, tax rates at such levels would probably not be economically feasible.

My take: It's worth noting that plenty of liberals and Democrats think it would be just fine to return top rates to just the stratospheric levels examined by the CBO. (I appear with them all the time on TV.) The (silly) argument: The economy did just fine at those rates in the 1950s—why not today? I believe John McCain's policy director, Douglas Holtz-Eakin, gave a pretty good answer in a chat with me not long ago:

Because you would also have to root for a world war and have the other economies in the world literally in ruins. That is not something to root for, and we also don't want an era like in the '70s with very high marginal rates, and it was a really awful period and anyone who lived through it doesn't relish going back to it.... We have learned some things, and those lessons should not be lost.

Is Obama advocating taxes at the extreme levels examined in the CBO study? No. But if we refuse to cut entitlement spending, that is the inescapable budgetary destination. And as I have pointed out, reducing projected increases in entitlement spending would allow lower payroll tax rates and free up dollars for other investment priorities. It would be the ultimate middle-class tax cut. How would this work. As I wrote recently:

Let's focus just on Social Security, since the fixes there are pretty straightforward. Two of the most common solutions to the program's long-term solvency problem are extending the retirement age and indexing benefits to inflation rather than to wages. Implementing those two solutions would actually result in more money going into Social Security than is needed to fund scheduled benefits. There would be money left over to help reduce taxes or increase spending on education or energy or whatever.

As Andrew Biggs of the American Enterprise Institute explains it, Social Security has a $5 trillion deficit over the coming 75 years: "This amount is a present value, which means that if you had $5 trillion today—earning interest at the government bond rate—you could draw it down over time to pay full benefits for 75 years." Now if you did a combination of price indexing starting in 2015 and extended the retirement age to 70 by 2050, that $5 trillion deficit turns into a $2.87 trillion surplus.

Of course, Medicare is an even bigger problem than Social Security. But look at it this way: The current projected 10-year annual growth rate for all mandatory spending is 5.7 percent. If that amount were reduced to 4.7 percent, notes Chris Edwards of the Cato Institute, we would save $253 billion in 2018 alone.