5 Reasons Taxes Are Going to Rise

John Boehner is no George H. W. Bush. At least that's his line for now. The Republican House Speaker has famously insisted that new taxes are a "nonstarter" in negotiations over how to slash the federal debt. Unlike Bush, who relented on his 1988 campaign pledge not to raise taxes and lost the presidency after one term, Boehner insists that he'll never be that wishy-washy. Read his lips.

[See where to work if you want a raise.]

Nice rhetoric. But lousy math. Boehner and his GOP allies apparently envision some kind of utopian America in which efficiencies and fairy dust magically solve a gigantic mismatch between what the government earns and what it spends. Spending cuts obviously need to be part of the solution, but if they were the only solution, America would become a place unrecognizable to many of its citizens. Popular social programs like Medicare and Social Security would end up gutted. Poverty would skyrocket. Homeownership rates would plummet. The U.S. military would shrink to half its current size, or less.

I'm not arguing with the policy prescriptions. We have, in fact, become a nation with an overdependence on government and a deficit of self-sufficiency. I'm arguing with the sophistry of denying the inevitable. Virtually every credible expert on the deficit agrees that it will take tax hikes and spending cuts alike to make Washington solvent again. Even Wall Street free marketeers are losing patience with Republican intransigence on taxes, because it's delaying a solution and making the problem worse. "Republicans have to stop the delusion that they can have growth and a reduced deficit without raising taxes," economist Nouriel Roubini said at a recent conference sponsored by the nonprofit Milken Institute. "Republicans are in la-la land. They want social spending like in Europe, with taxes like under Reagan. That's not feasible."

Many Democrats are in la-la land too, insisting that expensive programs like Medicare can somehow carry on without extensive reforms, or that merely taxing the rich will be enough. Those are fictions, too. But the Democratic position on deficit-reduction—represented by President Obama's recent proposal to enact about $1 of tax increases for every $2 in spending cuts—at least recognizes the general need to shrink government. Republicans, however, continue to insist that tax increases are off the table, not even worthy of consideration.

[See 3 ways to spot small-government phonies.]

Sure, that's political posturing, meant to position Republicans for the best possible gains in the 2012 elections—something the Democrats are doing too, in equally devious ways. But there are two dangers to clinging to the no-new-taxes fantasy. First, it's basically a lie to voters, which trivializes the severity of the debt problem and delays the point at which voters come to terms with the sacrifices they're going to have to make. And second, that delay raises the risk of a debt crisis, triggered by global investors demanding higher interest rates on Treasury securities to account for Washington's fiscal recklessness. If that happens, the cost of solving the debt problem—and the pain borne by taxpayers—will skyrocket. Here's why it's inevitable that taxes are going to rise:

The nation's debt is simply too big. The United States has been spending well beyond its means for a decade, borrowing to make up the difference and racking up debt that now totals more than $14 trillion—about the size of the entire U.S. economy. This year, the government is on course to spend about $3.8 trillion, while taking in just $2.2 trillion, mostly through taxes. So it's borrowing to finance an astonishing 42 percent of its spending. For anybody who thinks it's easy to cut 42 percent of all federal spending (and still get reelected), here's how that spending breaks down:

Social Security and Medicare, the government's two most popular programs, account for 39 percent of all spending.

Defense accounts for 20 percent.

Medicaid, which helps keep our embarrassingly high poverty rate from being even higher, accounts for 7.5 percent.

Interest on the debt, which must be paid unless Washington is willing to default and cause a global depression, is 5.4 percent of federal spending.

Everything else—which includes running the government, keeping the federal courts and foreign embassies open, managing the air-traffic control system, building and maintaining interstate highways, offering aid to victims of floods, hurricanes, and tornadoes, and thousands of other functions no other entity can really handle—accounts for the other 28 percent of spending.

[See what voters need to know about America's debt.]

Some of that can surely be cut without ruining the republic. But not 42 percent of it. Plus, government spending accounts for about 25 percent of GDP, and reducing that below the historical average of 20 percent or so would cause wrenching change in an economy that's not strong enough to handle it. It's probably true that the economy would adjust eventually, and become more efficient. But that would only happen after another bout of deep recession and high unemployment that could easily be worse than what we just went through. What politician is going to bring that on? Certainly not one who needs to face voters in the next election. All of this explains why budget experts view new revenue—otherwise known as tax increases—as an essential part of solving the budget problems.

We've been on a tax holiday. When Ronald Reagan left office, federal tax receipts amounted to 18 percent of GDP. When Bill Clinton left office, they were 20 percent of GDP. Today, the government's tax receipts are just 14 percent of GDP. That's on account of the 2001 and 2003 Bush tax cuts—extended by Obama until the end of 2012—and a decline in tax receipts caused by the recession. If the economic recovery continues, tax receipts will rise a bit, but with 7 million fewer workers than before the recession, federal tax receipts will stay below historical averages for the foreseeable future. At a minimum, they need to return to the 18- to 20-percent range that has been typical since the 1980s. Higher, maybe, to accommodate the swell of baby boomers who will be drawing on Social Security and Medicare.

[See 7 ways to sink in a stagnant economy.]

Taxpayers may not feel like they've been getting a tax break, for a couple of reasons. First, median income has been stagnant and it fell during the recession, so the typical family isn't getting ahead and may even be falling behind, after inflation. And state and local taxes are going up in many places, raising the overall tax burden. But that doesn't change the fact that the federal government has been borrowing from the future for a decade. The future has now arrived.

Voters don't want deep spending cuts. Americans are definitively conflicted. They want smaller government, whatever that is, but they don't want cuts in the most cherished programs, which is the main way to get smaller government. In a recent poll by Pew Research, voters said they favor increased government spending—rather than cuts—in 16 out of 18 categories they were asked about, including education, Medicare, Social Security, law enforcement, and environmental protection. Americans don't want their taxes raised either—who would?—but they seem to be more realistic about what's necessary than politicians in Washington. In another Pew poll, for instance, 64 percent said that reducing the deficit is likely to require both spending cuts and tax increases. And they're split evenly on the need to cut Social Security and Medicare spending, and raise taxes.

[See why baby boomers are bummed out.]

Tax hikes need not be disastrous. There's no doubt that it's a bad time to raise taxes. The economy is barely recovering and many families feel pinched already. But it's possible to raise taxes in ways that minimize the pain and give taxpayers something back in return. If tax hikes were phased in gradually, for instance, that would reassure the investors who fund Washington's borrowing while giving taxpayers time to prepare and pushing the burden out to a time when the economy ought to be healthier. A simplified tax code with fewer loopholes could raise extra tax revenue without higher rates, as long as it allowed fewer exemptions. That would also tilt the tax code back toward the little guy who's unable to afford expensive tax advisers, improving fairness.

The idea of a national sales tax hasn't caught on, but if it did, it could raise so much money that it might even be possible to cut income taxes, while at the same time giving Americans more reasons to save their money and fewer to spend it. And to appease conservatives who worry that a big pot of new money will simply fuel the endless growth of government, tax hikes could be structured to commence only when spending targets have been met. There are a lot of sensible ways to raise taxes without wiping out the middle class or creating an endless legacy of government waste.

[See why the middle-aged are missing out on new jobs.]

We may end up with no choice. Nobody's quite sure what a debt crisis will look like if or when it happens, but if there's a downgrade in the quality of U.S. debt or some other trigger, it will force Washington to actually shrink its debt instead of just talking about it—and do it quickly. That means it may have to enact spending cuts or tax hikes without the phase-ins that would allow taxpayers time to prepare. If that happens, a compromise involving tax hikes and spending cuts will be more politically palatable than a deal relying on cuts alone, because it will spread the pain more broadly than if the burden fell squarely on a select group of taxpayers who happen to be most dependent on government. That may be how Washington ends up doing the right thing, after exhausting all other options.

Twitter: @rickjnewman

Corrected on 5/13/11: A previous version of this story incorrectly stated that George W. Bush ran for president in 1988. It was George H. W. Bush.