Divergent messages from the Obama administration in the past two days hint at a tough political reality: Nobody likes higher taxes, but that may be the price of getting America's fiscal house back in order.
Although Barack Obama campaigned on a pledge of no tax hikes on the middle class, top administration officials on Sunday appeared to open the door to rethinking that position. Then on Monday the White House press secretary said the door really isn't open.
Either way, the discussion of possible tax hikes is already out of the stable. Economists generally agree with Treasury Secretary Timothy Geithner that the nation is on an unsustainable fiscal path, and that hard choices will need to be made – although the reckoning may not occur on Mr. Obama's watch. Some say the magnitude of the hole to be filled is so large that spending cuts alone are unlikely to do the job.
"It’s going to take a combination of things that will slow the growth of spending ... and increasing [tax] revenues," predicts Jim Horney, a budget expert at the Center for Budget and Policy Priorities, a left-leaning Washington research group. Virtually “all agree that under our current path we’re going to see over time an explosion in deficits and debt."
The path of inaction would have serious consequences, he warns: slower economic growth, greater risk of rising interest rates, and a growing burden of debt dumped on younger generations of Americans.
Political peril of tax hikes
But the path of action has consequences, too, if tax hikes are involved. Just ask George H.W. Bush, who lost the White House in 1992 after departing from his pledge, "Read my lips: No new taxes."
In the election, Obama pledged that tax rates wouldn't rise for Americans with household incomes below $250,000 a year. Recent polls confirm that Americans are generally not in a mood for a broad tax hike. Asked if they are willing to pay more taxes to reduce the federal deficit, 56 percent said no and 41 percent said yes in a New York Times/CBS News survey late last month.
Deficit outlook worsens
But the mammoth federal spending designed to lift the economy out of recession, coupled with a recession-related slump in tax revenues, has made the outlook for budget deficits much worse. Add the projected costs of covering healthcare for baby-boomer retirees and, possibly, those who are currently uninsured, and it's clear why the issue of taxes is weighing heavier on the public and politicians lately.
In a televised interview on ABC on Sunday, Secretary Geithner talked about the need to make "hard choices" to rein in federal budget deficits. And the president's top economic policy adviser, Larry Summers, said on CBS that healthcare reform will cost money, and "it is never a good idea to absolutely rule things out."
Is this code language for reconsidering a middle-class tax hike?
The 8 percent solution?
Whereas conservatives talk about solving the budget problem by cutting spending, and liberals (including Obama) call for making the highest-earning Americans pay more, the scale of the challenge may end up defying those prescriptions. The federal deficit "is projected to average at least $1 trillion per year for the 10 years after 2009, even if the economy returns to full employment and the stimulus package is allowed to expire in two years," economists William Gale of the Brookings Institution and Alan Auerbach of the University of California, Berkeley, concluded in a study earlier this year.
They say the US must close a gap equal to about 8 percent of gross domestic product. That means if the nation acts now, taxes must either go up that much or federal spending must go down that much, permanently, to put government finances on a sustainable course.
For comparison, federal revenues totaled about 18 percent of GDP in 2008.
To close the whole gap with tax increases might crimp economic growth, as the government grabbed a larger share of national income. Spending cuts of that magnitude might displease legions of voters who – whatever they may say about bureaucracy – rely on government services. It's hard for policymakers to agree to a shift that big all on the spending side, or all on the tax side. In the past, Mr. Horney says, progress on budget deficits has generally come with compromises on both sides of the ledger.
Not everyone agrees on the size of the so-called "fiscal gap." But budget experts agree that the gap grows progressively larger, as a percentage of GDP, with each year of delay. The nonpartisan Congressional Budget Office offers one scenario outlining the gap being 8 percent of GDP if action is taken today, and 12 percent of GDP if action is taken in 2030.
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