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WISER: Reducing the debt — spending cuts vs. tax increases

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President Obama renewed his push to only extend the Bush-era tax cuts for families who earn less than $250,000 a year earlier this week, a proposal also included in the president’s recommended 2013 budget. Obama couched the tax increase as a means of curbing mounting deficits and the national debt of almost $16 trillion

“I might feel differently if we were still in surplus. But we’ve got these huge deficits, and everybody agrees that we need to do something about these deficits and these debts. So the money we’re spending on these tax cuts for the wealthy is a major driver of our deficit, a major contributor to our deficit, costing us a trillion dollars over the next decade.”

An analysis of the president’s budget, however, belies the notion that his tax proposals will begin to make a sizeable dent in annual deficits. The Congressional Budget Office has projected that revenues would increase by $91 billion in 2012 under Obama’s budget, or about 7 percent of the projected 2012 deficit of $1.25 trillion. 

Tax cuts also haven’t always been a significant contributor to deficits, as Obama claims. When Ronald Reagan first cut taxes in 1981, overall revenues decreased by $17 billion between 1982 and 1983, according to the CBO. But after the passage of comprehensive tax reform in 1986 — the only complete overhaul of the Internal Revenue Code since 1954 — overall revenues increased by $128 billion between 1987 and 1989. The 1986 plan condensed the income tax structure into two rates, 15 and 28 percent, whereas Obama’s proposal would hike the rates on top earners to 36 and almost 40 percent.

The Bush tax cuts of 2001 and 2003 initially resulted in a dip of $211 billion in income tax revenues between 2000 and 2003. They then increased by $370 billion between 2003 and 2007, according to the CBO. Again, a mixed record, but not necessarily a major inducer of deficits either.

The real genesis of trillion-dollar deficits has been federal spending. After inheriting $3.4 trillion in debt held by the public (debt held by individuals, corporations, state, local and foreign governments), Bush doubled that amount during his two terms. Obama has continued that trend, resulting in the current level of about $11 trillion in debt held by the public.

With the spending debate in Washington often centered around what would constitute a “balanced” approach to reducing the debt, a report released by the American Enterprise Institute in 2010 found that successful attempts to restore fiscal solvency are more likely to include spending cuts that outweigh tax increases.

The report analyzed several studies of countries in the Organization for Economic Co-operation and Development between 1970 and 2007. OECD countries that successfully reduced debt — using the standard of a 4.5 percentage point reduction in the ratio of debt to potential GDP — implemented plans with average shares of 80 percent spending cuts to 20 percent tax increases (page 38 of report).

The spending cuts-heavy approach is embodied in the budget proposed by Rep. Paul Ryan, Wisconsin Republican, which would lower federal debt held by the public to 53 percent of GDP at the end of 2030 and 10 percent at the end of 2050 by slowing the growth of entitlement spending (The CBO recently projected that the debt will rise to 70 percent of GDP by the end of this year). Revenues would increase from 15.5 percent of GDP in 2011 to 19 percent in both 2030 and 2050.

Obama, whose own budget would accumulate a deficit of $6.4 trillion (or 3.2 percent of GDP) between 2013 and 2022, derisively labeled Ryan’s proposal as “nothing but thinly veiled Social Darwinism” earlier this year

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Daniel Wiser

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