The Biden administration proposes increasing taxes on high-income individuals and businesses. In light of enormous government debt, one could be forgiven for seeing it as a step toward fiscal responsibility. However, it’s not.
Let’s start with the fact that it’s not nearly enough money to cover the increases in spending the administration has been eyeing. The White House estimates it will take 15 years of increased corporate taxes to cover eight years of spending from its proposed infrastructure package, the American Jobs Plan. Meanwhile, revenue from the proposed tax increase on high earners and their pass-through businesses will be enough to cover just over one-third of the $1.8 trillion in social spending that would come with the American Families Plan.
Faced with the choice, it may be more fiscally responsible to cut taxes than to increase them. As Milton Friedman said, “Governments spend whatever they take in, and then whatever they can get away with.” So if they take in less, they can be expected to spend less.
Yes, there have been periods when the U.S. government has cut taxes and increased spending (or raised taxes and cut spending). Nevertheless, this principle applies in the long run. Countries with high spending — think Scandinavia — have relatively high taxes, while those that spend a smaller share of national income have lower taxes.
The argument for reducing taxes starts with the premise that government spending is too high, in spite of politicians’ endless efforts to win voters’ support by spending more. Regardless of how it is financed — and of popular political sentiment — government spending is less effective than money spent privately on goods or services. When a private firm produces a good or service, market prices and competition give it an incentive to meet consumer needs at the lowest cost.
Higher tax rates reduce incentives to do whatever it is that is taxed. Income taxes reduce the incentive to work, taxes on profits reduce the incentive to invest, and sales taxes reduce the incentive to buy and sell. That’s why taxpayers lose more than a dollar for every dollar collected. If the costs of collecting and enforcing taxes are included, the loss is even larger. For all these reasons, it is even possible to increase taxes to the point where you wind up with less tax revenue.
Government spending is needed to pay for some things, such as national defense and transfer programs like Medicaid and food stamps. But President Joe Biden is proposing to spend on electric vehicles and charging stations, research and development, childcare, and other things that could be better provided by the private sector. We should be looking for ways to free up more resources for private production, rather than crowding it out with inefficient bureaucracy.
There are a few objections to “starving the beast” to force spending cuts. One is that a history of large deficits may increase politicians’ and the public’s tolerance for debt. Another is that it may make it harder for the government to pay for what seniors have come to expect from Medicare and Social Security.
The current generation of workers pays Social Security and Medicare taxes every year, so they are entitled to a decent return on what they have paid in. But government is not collecting enough in Social Security and Medicare taxes to pay all scheduled benefits, and the shortfall is increasing over time. Given the enormous size of the debt and its continued growth, the rising share of the budget needed to cover interest costs, and demographic trends, this can’t go on forever.
Unfortunately, increasing taxes this year probably would not have much effect on the government’s ability to pay future Social Security or Medicare benefits. It would be better to eliminate shortfalls by combining reforms with tax increases targeted specifically toward paying retirees.
Biden would not be the first president to band with Congress and spend without considering how much we’ll need to borrow, but his plans to increase taxes are not much better. They could prolong the government’s ability and willingness to spend excessively. There is a point at which private investors and foreign governments will no longer be willing to buy all the debt the Treasury issues — the question is when.
If Congress reduced taxes, it could hasten the time when the federal government substantially limits discretionary spending. If so, we could look forward to a freer, more prosperous economy and a smaller government.
Tracy C. Miller is a senior policy research editor with the Mercatus Center at George Mason University.