A Thousand Cuts: The Tax Version

The Center for American Progress recently released "A Thousand Cuts," which detailed what spending cuts could be adopted to achieve primary budget balance (eliminate the deficit excluding interest) by 2015 (see our discussion of the report here). The Center looked at scenarios in which 33, 50, 67, and 100 percent of deficit reduction would be achieved through spending cuts.

We've decided to take a look at the tax alternatives to this situation. In other words, what must/could we do to eliminate 33, 50, 67, and even 100 percent of the primary deficit using just tax increases?

Starting from the President's Budget as a baseline, as CAP did, we aim for $255 billion in deficit reduction in 2015. Basically, you could call this "Seven Tax Increases" since we will be using seven levers in total to hit each target. We have decided to use the levers on income, consumption (excise taxes and a Value-Added Tax), and changing the tax formula to a more realistic measure of inflation.

The varying deficit reduction scenarios would have different impact on taxes encountered by most Americans. As seen below, the 33 percent reduction scenario would be achieved by allowing the 25 and 28 percent brackets to expire, returning to their Clinton-era levels of 28 and 31 percent, respectively; a tax increase to 25 cents per ounce on alcoholic beverages, instituting an excise tax on sweetened beverages and raising the gas tax by 15 cents (up from the current 18.4 cents per gallon). Since about 100 million filers (both individuals and families) have taxable income, the average tax increase per taxpayer would be about $850 per year in this case, to lower the deficit by $85 billion in 2015.

The 50 percent reduction scenario builds on the 33 percent version and includes indexing the tax code to a "chained" CPI and also raise the gas tax by 40 cents per gallon to 58.4 cents per gallon. This scenario would cost taxpayers roughly an additional $1,300 per year.

The 67 percent reduction scenario builds on the 50 percent version (except it removes the gas tax) by instituting a carbon tax with some rebates for lower-income households. On average, this scenario would cost taxpayers an additional $1,700 each per year.

And finally, the 100 percent reduction scenario--or complete elimination of the primary deficit by 2015 through tax increases alone--would build on 67 percent scenario by instituting a new tax, a Value-Added Tax (VAT) of 5 percent with half of the proceeds returned to lower and some middle-income consumers. This option would cost taxpayers an additional $2,550 per year.

(Obviously, the amount each taxpayer would see is an average with some paying much less and others paying more).

Letting Middle Income Tax Cuts Expire:

  • All Scenarios: Allow 25 and 28 percent brackets to expire, returning to their Clinton-era levels of 28 and 31 percent, respectively. This would effectively allow the tax cuts for the upper four marginal tax brackets to expire (since the President's budget would already allow the top two income tax rate cuts to expire). However, the 25 and 28 percent brackets could be renewed temporarily, say to 2012, so as not to undermine the recovery, and then allowed to expire.

Increase Excise Tax on Alcoholic Beverages:

  • All Scenarios: Increase to 25 cents per ounce.

Institute Excise Tax on Sweetened Beverages:

  • All Scenarios: Institute a one cent tax per ounce for all sweetened beverages.

Increase Gas Tax:

  • 33% Scenario: Increase of 12 cents per gallon to 30.4 cents.
  • 50% Scenario: Increase of 40 cents per gallon to 58.4 cents.

Index Tax Code to "chained" CPI:

  • 50%, 67% and 100% Scenarios: Moves to the chained CPI-U from the CPI-W, which experts believe actually overstates inflation and which would make tax brackets move upward more slowly.

Institute a Carbon Tax:

  • 67% and 100% Scenarios:  Impose a tax on carbon emissions, with roughly 85 percent going toward deficit reduction and the remaining proceeds returned to consumers via energy rebates.

Value-Added Tax (VAT):

  • 33%, 50%, 67% Scenarios: Do not implement.
  • 100% Scenario: Five percent VAT would be instituted. Half of the proceeds would go toward deficit reduction while the other half would go toward rebates for consumers.

The deficit reduction numbers for each policy in each scenario are in the table below. (Note: these numbers are rough estimates and should not be taken as exact figures).

Savings from Different Policies Under Each Scenario (2015, billions)
Policy 33% 50% 67% 100%
Let Middle Income Tax Cuts Expire $50 $50 $50 $50
Increase Excise Tax on Alcoholic Beverages $5 $5 $5 $5
Institute Excise Tax on Sweetened Beverages $15 $15 $15 $15
Raise Gas Tax $15 $50 $0 $0
Index Tax Code to "Chained" CPI $0 $10 $10 $10
Carbon Tax $0 $0 $90 $90
5% VAT With Rebate $0 $0 $0 $85
Total Revenue $85 $130 $170 $255
Unspecified Spending Cuts $170 $125 $85 $0
Total Savings $255 $255 $255 $255

Note, however, that the options profiled here by no means form an exhaustive list. For simplicity's sake, we included only a few key levers in our analysis--but in reality, there are many options for deficit reduction, and all of them should be on the table. For example, we did not use tax expenditures because CAP included many of them in their spending cuts, and most of them are far more similar to spending than tax policy. All of these could also potentially be used as levers. Also, the VAT used here would have a relatively narrow base, as do many other countries, and for simplicity we assume roughly half of all consumption activity would be taxable under the VAT.

Overall, this is meant to be an exercise, similar to what CAP did. CRFB does not necessarily support these changes, but we wanted to see what a solution focused on revenues could look like. Clearly, these tax increases also are quite significant, just as the spending decreases CAP found would be. Revenue increases of this magnitude, even using the 33 percent scenario, show just how much of a hole we have dug for ourselves and how large of a ladder we will soon require.

Again, hats off to CAP for putting together such a great demonstration.

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