We have a problem.
The Congressional Budget Office (CBO) last May warned that the federal
deficit
was high by historical standards. The federal deficit is on autopilot to reach
6.1%
of GDP annually in nine years. That is optimistic, as the existing federal deficit approaches
100% of GDP
.
Under a realistic scenario, debt would reach
138%
of GDP in 2032, deficits would reach 10.1%, and interest payments on the debt would total 4.4% of GDP. These projections underline an
unsustainable fiscal trajectory
. The major challenge is increased spending on benefits for the elderly. The U.S. population is aging and population growth is slowing. The dependency ratio is rising. Entitlement reform is an absolute necessity.
But higher federal taxes are also necessary. The U.S. is not going to grow its way out of the deficit problem. As the Bureau of Labor Statistics
noted
in April 2021, “In the years since 2005, labor productivity has grown at an average annual rate of just 1.3%, which is lower than the 2.1% long-term average rate from 1947 to 2022.” Trend productivity in the U.S. is under 1.5%. Population growth in the U.S. is about 0.5%.
That matters because economic growth is determined by productivity plus increased employment. Basic economics says the economy cannot grow faster than 2% a year, at least not on the sustainable basis needed to address the trend deficits. Federal spending over the course of the next decade will grow at 5% or higher. The Federal Reserve will bring inflation down to its 2% goal. On a secular basis, real economic growth will be 2% or so. Again, however, federal spending is growing at 5% or more. The deficit is growing and, in turn, reducing investment and long-run growth.
Higher federal taxes must be part of the solution to reduce the deficit. The best policy would be to raise revenues in a manner that does not reduce economic growth. That is to say, to raise taxes in a way that minimizes disincentives to work and to invest. Economists say that Pigouvian taxes are the least likely to have a negative impact on economic growth. Pigouvian taxes are taxes on goods and services which have negative externalities that the price system does not capture. For example, a tax on sugar would be a Pigouvian tax, which would certainly help America with our obesity problem.
Taxes on real property and real estate would also be less likely to reduce economic growth. Under the U.S. tax code, a tax on the imputed income from owning a residence would not be unconstitutional. Congress could pass legislation for a progressive imputed income tax from owning a residence, and it would be an effective way to raise revenue and tax conspicuous residential housing consumption. A progressive tax on imputed residential income would also not reduce long-run growth.
But we must be cautious: taxes on businesses and excessive taxes on high earners who provide society with what it most wants are the most harmful to economic growth.
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James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes
a daily note
on finance and the economy, politics, sociology, and criminal justice.
