The Gorge View of the 2013 Tax Cliff

In the fall of 2011 several stories arose regarding the 2013 tax cliff. Those stories are once again appearing in the media and will likely accelerate as we come closer and closer to 2013. What is the tax cliff? Basically the tax cliff is the massive acceleration in taxes come 2013 and going forward:

(1) Bush era reduced tax rates expire,

(2) temporary tax holiday regarding payroll tax expire,

(3) proposed increase in marginal tax rates proposed in the so called “Obama Jobs Plan” come into effect,

(4) the laundry list of tax increases associated with ObamaCare come into effect,

(5) proposed “Buffet Rule” taxes.

　

Hence the tax cliff is depicted as a massive acceleration in taxes and the consequential depressing effect on economic activity [when you tax something you get less of it, if you tax it more, you get even less of it]. (1) (2)

Few take the position of those at the bottom of the gorge looking up at the tax cliff. That is, those proponents of such massive tax increases who believe the massive accelerated tax increase will generate a bounty of government revenue. Yes, those at the bottom of the gorge looking up at the tax cliff.


Three items one needs to consider regarding those awaiting in the gorge:

(1) government spending, more succinctly politico spending through the mechanism of government, has accelerate in the last twelve years accentuated by a massive spending increase in the last four years,

(2) this new spending level, the summation of the last twelve years with special focus on the last four years, is now politically framed as “necessary, needed, required” [albeit no empirical evidence is forth coming, the level is merely argued from the notional proposition of “the way things ought to be“],

(3) the new politically framed “necessary, needed, required” spending level must then be, as the political argument goes, matched by a revenue level that matches the supposed “necessary, needed, required”.

A problem looming for the gorge dwellers is Hauser‘s Law. What is Hauser's Law? Hauser's Law states regardless of the mix of tax and tax preferences, tax will yield revenue just under 19% of GDP. That is:

"Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."

Over this period there have been more than 30 major changes in the tax code including personal income tax rates, corporate tax rates, capital gains taxes, dividend taxes, investment tax credits, depreciation schedules, Social Security taxes, and the number of tax brackets among others. Yet during this period, federal government tax collections as a share of GDP have moved within a narrow band of just under 19% of GDP." (3)

Hence the new politically framed “necessary, needed, required” spending level mantra of the gorge dwellers amounts to approximately 24% of GDP. Therefore 19% does not match 24% and moreover in a depressed economy the tax cliff may well generate well below the 19% “average” explained by Hauser’s Law.


　

Notes:

　

(1) http://www.naturalnews.com/news_000615_Heading_towards_2013_tax_cliff.html

(2) http://online.wsjWSJ_hp_mostpop_read

(3) http://online.wsj.com/article/SB10001424052748703514904575602943209741952.html

Keith Hennessey of Stanford University Explains Ratio Gimmicks in the President’s 2013 Budget.

“The Obama Administration claims their new budget contains $2.50 of spending cuts for every $1 of tax increases. Here is White House Chief of Staff and former Budget Director Jack Lew on Meet the Press yesterday:

'We’ve seen from Republicans in–particularly Republicans in the House, but with Republicans generally, that they don’t want to be part of any plan that raises taxes at all. The president’s budget has $1 of revenue for every $2 1/2 of spending cuts. This can be done, but it can only be done when we work together.'


Their 2.5:1 ratio is bogus. The President’s team is (1) playing a timeframe game and (2) counting interest savings from tax increases as spending cuts.

Contrary to Mr. Lew’s assertion, the President is proposing at least $1.20 of tax increases for every dollar of proposed spending cuts. The President’s budget locks in historically high spending levels and relies more on tax increases than spending cuts for the limited deficit reduction it proposes.

Table S-3 from the newly released President’s Budget starts measuring deficit reduction a year ago, in January 2011. The table shows $5.3 T of deficit reduction over the next ten years resulting from a combination of laws enacted last year and the President’s new proposals released in today’s budget.

The President’s budget is a set of policy proposals for the future. When most people hear the “The President’s budget has $1 of revenue for every $2 1/2 of spending cuts,” they think this ratio applies to the changes the President proposes for the future.

I will therefore split the OMB table and recalculate this ratio, ignoring spending cuts and tax increases that have already been enacted into law and looking only at future policy proposals. I argue this is the right way to do this ratio. Like the OMB table, this one shows deficit reduction for the next 10 years ($ in billions, 2013-2021).

	Already enacted	New proposals	Total
spending cuts	1720	1254	2974
tax increases		1510	1510
interest effects			800
total deficit reduction	1720	2764	5284
spending / taxes		0.83	2.50
taxes / spending		1.20

Looking only at new proposals, the President’s budget proposes 83 cents in spending cuts for each dollar it proposes in tax increases. Or we could say the President’s budget proposes $1.20 in tax increases for each dollar in proposed spending cuts.

The gimmicks

The President’s team is playing at least two games to generate their 2.5:1 ratio:


They are cherry-picking their timeframe to make the ratio look at high as possible;
-and-
They are counting all interest savings as spending cuts.
　
Why did they start measuring in January 2011? Because that was the start of the Republican Congress, because last year only spending cuts were enacted, and because that timeframe maximizes the spending increase to tax cut ratio.” - Keith Hennessey, 02/13/2012


The entire essay, The ratio of spending cuts to tax increases in the President’s budget, appears in the link below:


http://keithhennessey.com/2012/02/13/bad-ratio/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+KeithHennessey+%28Keith+Hennessey%3A+Your+guide+to+American+economic+policy%29