Will the Escalating U.S. Deficit Spur Americans to Pay More Taxes?Published: April 15, 2010 in Knowledge@Emory
U.S. politicians and voters alike face a Gordian knot when it comes to the federal deficit, which is likely to swell to $1.5 trillion for fiscal 2010, up from $1.4 trillion in 2009, according to the Congressional Budget Office. “Most of the increase in the federal deficit,” says Alan Abramowitz, a chaired professor of political science at Emory University, “can be attributed to a combination of the effects of a severe recession on tax revenues and the unfunded expenditures of hundreds of billions of dollars on a new prescription drug benefit for seniors along with the wars in Iraq and Afghanistan.” The nonpartisan National Priorities Project, which has kept a running tab on cost of the two wars since 2001, recently reported that with the approval of the fiscal 2010 defense spending bill, the wars’ price tag has topped $1 trillion dollars.
Now that the economic flush years are over, many states find themselves in similar financially precarious straits. Like buyer's remorse after a spending spree, government units are scrambling to rebuild financial stability in the face of continued economic hardship.
But the problem goes beyond that of balancing a checkbook, according to faculty at Emory and its Goizueta Business School. Instead, the deeper issue is whether or not Americans are willing either to pay for the services they demand, or to make do with a less responsive government.
For several years, a booming economy let the country have it both ways, but now, some observers say, Americans may have to put up or shut up.
“The primary problem can be traced to the vast obligations that were taken on by the federal government after World War II that are now coming home to roost,” says Jagdish Sheth, a corporate strategist and chaired professor of marketing at Goizueta. “Partly as a response to the Great Depression, the U.S. committed itself to a social security program that depended on younger workers paying in to support older workers. But the demographics didn’t work, since declining birthrates, increased life expectancy and restrictive immigration policies meant that the growth in the volume of the elderly outstripped the growth of the younger population that was needed to fund the system.”
Advances in technology have actually added to the challenge, Sheth notes.
“During the last 40 years, the U.S. has shifted from a manufacturing based economy to a services based one,” he says. “That, plus the fact that more processes are being automated, has driven a relative decline in the number of permanent jobs.”
Similar to the way in which the decline in U.S. birthrates is shrinking Social Security funding, a dwindling workforce is hurting automakers and other industries with a high level of legacy pension programs.
“On average, a single General Motors employee is helping to fund the pension obligations of up to eight retirees,” Sheth says. “The numbers simply don’t work anymore.”
Abramowitz contends that Social Security is not facing a serious crisis, and that “it would only take some fairly minor reforms to keep it solvent for many years to come.” Considerable economic growth would of course boost the program’s funding and help reduce the deficit, but the U.S. economy is just about wrung out, Sheth says. “Instead, overseas markets, which are still growing, do represent an opportunity for U.S. investment, but that’s not politically acceptable right now,” he says.
Given the obstacles to large-scale economic expansion, Sheth suggests an overhaul of the U.S. tax system may be in order.
“The current tax system is anchored to income and wealth,” he observes. “Instead, it might be better to shift the emphasis to a consumption basis with a Value Added Tax [VAT], a kind of a sales tax that is incurred by producers at each stage of production.”
Although producers initially pay the VAT, the cost is generally passed along to consumers, thereby functioning as a kind of consumption tax.
In the short term, Sheth says a VAT could co-exist with the current income tax structure, although ultimately he suggests junking the so-called progressive tax system—where the rate rises with income but is also filled with loopholes designed to meet social and political goals [credit card interest, for example, is not generally deductible on an individual return, but mortgage interest is, as a way to encourage home ownership]—and instead replacing it with a flat tax rate.
Abramowitz, on the other hand, argues that “consumption taxes such as the proposed VAT tend be highly regressive unless they include a mechanism for refunding these taxes to lower income households.” The reason, says Abramowitz, is that “lower income households typically spend a much larger proportion of their incomes on necessities such as food, shelter, and clothing.” Abandoning the progressive tax system, which is based on the ability to pay, in favor of a consumption-based tax, he says, “would have the effect of reinforcing rather than offsetting the increasingly unequal distribution of wealth in the U.S.”
Other faculty members agree that the burgeoning budget deficit is largely tied to the federal government’s social engineering programs, and a lack of willingness to pay for them.
The new prescription drug benefits for seniors, for example, as well as the wars in Iraq and Afghanistan, represent “massive expenditures that Congress and the Bush Administration deliberately paid for through deficit spending,” says Abramowitz—“rather than by raising taxes during a time of relative economic prosperity.”
Ray Hill, an assistant finance professor at Goizueta, says that “until this past year, I would have attributed the deficit to two broad causes. The first is that Americans have been shielded from the costs of the programs that the government has undertaken.” He points to Medicare as a prime example: “Everyone who works pays a Medicare tax, but this tax is not enough to pay for the present services provided by Medicare, much less the accumulating future obligations.”
At the margin, he notes, the government is paying for Medicare by borrowing, “rather than confronting the rising cost.”
Hill sees the recently passed health care reform bill as another example of this “pass the buck” attitude.
“This problem [of not being willing to ante up for government services rendered] was compounded by a belief that someone else, that is the ‘wealthy,’ would pay the tab,” Hill says. “Of course everyone wants health care ‘reform’ if they don't think they will be paying the bill for it. But this creates a problem at the macro level, since assessing higher tax rates on the ‘wealthy’ does not necessarily result in collecting higher tax revenues from them.”
Indeed, health care reform costs and other issues have driven the growth of the so-called Tea Party movement, which calls for a smaller government that spends less and that would presumably function with fewer tax revenues.
The second reason for the bulging deficit is a belief that additional government spending or tax cuts are necessary to get the U.S. out of the recession, Hill adds. “A majority of economists would probably support this Keynesian view.”
The problem, however, is the way in which the spending is administered.
“Under the traditional Keynesian pump priming, the additional spending is supposed to be temporary,” he says. “But it is difficult to turn off the spigot once economic recovery is underway.”
In some ways, Obama's budget approach is a replay of his predecessor's.
Although Democrat Bill Clinton left office with a significant federal surplus, George W. Bush quickly ran through it and turned it into a deficit. The deficit grew steadily during his first term, and then shrank during his next three years only to again swell during his last year in the Oval office.
Now, says Hill, the Obama administration has ratcheted up the process with a record deficit in its first year. This increase in the deficit is in part a result of the current recession, but some estimates predict continued deficit growth, on an absolute basis and as a percentage of Gross Domestic Product, that will eclipse anything we’ve seen in the post-World War II period.”
According to Hill, new health care reforms will only exacerbate the deficit at the state level, too. “We know that the recent health care bill imposes spending requirements on states that they cannot afford, given the current state of their budgets,” he says.
The real problem, Hill says, is an issue of accountability. "I have no hesitation laying the blame for the nation’s deficit at the feet of politicians. They have no problem spending other people's money and no courage to force taxpayers to confront the costs of the programs that the government takes on.”
“Budget deficits of this magnitude, absent a major world war, are a new phenomenon,” notes Randall Strahan, a political science professor at Emory. “The voting patterns in the November elections will likely offer clues to whether or not the public is comfortable with them.”
But even if voters are uncomfortable with the raging deficit, they may not necessarily be willing to take the steps necessary to tame it.
“The problem seems to be that people want certain services from the federal government, but they don’t want to pay for them,” Strahan observes. “Additionally, elected officials want to deliver benefits and tax cuts instead of tax increases. For a time they seemed to be able to do both, but the combination of the economic downturn and the rising tide of federal obligations means the situation is not sustainable over the long term.”
Right now there’s a lot of squawking about fiscal responsibility, but will politicians and the public face up to the mess and start paying down the debt?
“I think the financial markets will provide one signal of when it’s necessary to pay the piper,” Strahan says. “We’ve already seen some shots across the bow, including rumors of possible downgrades in the U.S. debt, a move that that would certainly get the attention of a lot of people.”
Strahan says the last serious effort to rein in the debt was back in the 1990s under the Clinton administration and after Republicans won control of Congress, “and that followed some serious signals from the financial markets.”
Another financial market backlash could also spark a new breed of politician, “like H. Ross Perot in the 1990s, who hammered away at the deficit problem and raised the visibility of the issue,” he adds.
Perhaps the issue today is whether or not Americans are willing to either pay for the services they demand, or are willing to make do with a less responsive government. Will health care be the catalyst that spurs voters to finally face that decision?
President Obama’s recently passed reforms could signal a turning point, Strahan says.
“The economic consequences of health care reform are huge, and will affect almost every individual and business,” he says. “Do the American people support it? I think the jury’s still out on that, but the November elections will provide a clearer answer to that question.”