If you're hoping that tax hikes on the rich will solve America's debt crisis, you're overestimating the power of the wealthy.
President Obama's budget proposal would raise taxes on upper-income earners by $969 billion over the next 10 years, yet the federal debt would continue to explode. To boost government revenues further, he'd raise an additional $122 billion from multinational firms, $90 billion from banks, $37 billion from oil companies, and $24 billion from hedge funds and private-equity firms. All told, that's nearly $1.2 trillion. And it would barely make a dent. We'd still have huge deficits, and the national debt would keep growing.
Taxing the rich will be one of the hot political stories this year. It will also divert attention from a much bigger story: Sooner or later, almost everybody in America is going to pay more in taxes. One reason is that spending on Social Security, Medicare, and Medicaid—which equals 56 percent of all federal outflows—continues to skyrocket, and cutting those programs, just as baby boomers begin to retire, would be politically perilous. Few politicians in Washington want to cut defense, which leaves little else on the chopping block.
At least 35 states face their own budget shortfalls this year, with revenue in many states coming in below projections that were weak to start with, according to the National Conference of State Legislatures. When federal stimulus spending winds down in 2011, many states anticipate a "cliff effect," in which their revenues plunge. That means new revenue will have to come from somewhere—and there aren't enough rich people to provide all the funds. "It's inevitable that the government will have to find a way to have a truly middle-income tax increase," says Clint Stretch of consulting firm Deloitte Tax. "The trick is: how?"
Politicians, of course, don't want to admit that most of their constituents face a stinging tax hike. And until there's no other choice, they'll try to raise funds without having to mouth the "T" word. As federal, state, and local governments get desperate, here are some of the mechanisms elected officials will try to use to raise funds without getting run out of office:
Expansion of existing taxes. Raising income tax rates is so unpopular that most politicians consider it a last resort. Raising state and local sales taxes is a bit more tolerable, and it's even better if you're simply expanding a tax that already exists. "In many states, the first thing they'll do is squeeze more out of the taxes they've got," says Alex Meleney of Deloitte Tax. Some states, for example, could expand sales taxes to things not already covered, such as restaurant meals, salons, business services, Internet connections, and phone or cable TV service. It also makes sense to crack down on those evading existing taxes, by increasing the fines for late payments and underpayments and conducting more inspections to catch merchants and others who may be skirting their obligations.
"Avoidable" taxes. A new levy is more palatable when politicians can make the case that you don't have to pay it if you choose not to. Consumers might be able to offset new gasoline taxes, for instance, by driving less or buying a more efficient car. Some states are mulling new energy or carbon taxes, with part of the pitch being that you can make up the difference by using less energy. Then there are the classic "sin taxes" on cigarettes and booze, which are only for people with unhealthy habits—and have already gone up in more than a dozen states, according to the NCSL. One new "sin" that could end up taxed: junk food.
Online taxes. This is controversial, because it could force online merchants to figure out tax rates for thousands of localities. But New York and a few other states are trying to impose regular sales taxes on Internet purchases, to replace revenue lost when those transactions don't take place in a physical store. A legal challenge to the so-called Amazon tax is pending in a New York court, and if the government wins, more states are sure to follow up with their own Internet taxes.
[If you like the bank tax, here are 13 others.]
Healthcare taxes. You'd think healthcare was already expensive enough, but at least nine states have upped taxes on hospitals and other providers over the past year, according to NCSL. Of course, many of those added costs will be passed on to insurers, businesses, and ultimately, consumers.
Less federal aid to states. The federal government gives states nearly $500 billion a year in the form of Medicaid payments, highway funds, housing aid, education grants, and other stipends. One way for Washington to rein in spending is to reduce aid to states, which could force states to cut their own spending even more—or, more likely, come up with new taxes to pay for it.
Temporary surtaxes. Several states have been covering budget shortfalls with "temporary" increases in income or property taxes or with other surtaxes that will supposedly expire at some point in the future. If the economy comes roaring back, sure, legislators may rescind those tax hikes. But more often than not, they stick.
Business tax hikes. Unemployment-insurance funds, which are financed primarily through a tax on businesses, are running low in many states, for obvious reasons. The federal government has been kicking in money for extensions, but that can't continue much longer. If the unemployment rate remains high—as even the White House now predicts—states will have to increase taxes on businesses to replenish their UI accounts. And the extra burden will flow through to workers in the form of lower wages. Businesses are also ripe targets for other taxes that governments don't want to impose directly on consumers.
A value-added tax. Some tax experts view this as the holy grail of revenue raisers and think it's inevitable that federal or state-level VATs—or both—will become common. A VAT is a tax imposed at various steps in the production of a good—i.e., every time "value" is added. Since there's no extra fee at the point of sale, consumers don't notice the way they would if the sales tax increased. But prices would go up, reflecting the added costs. VATs have been used to plug big budget shortfalls in Europe, Canada, and Japan, where they were intensely unpopular at first. But VATs also have some appealing benefits. Since they tax consumption, not income, they create incentives to earn and save more, which benefits the economy in the long term. They can be applied to select goods, with essentials like food exempt. And VATs can raise a lot of money in one fell swoop, which federal and state governments will need to do before long. Until then, be glad you're not rich.