Committee for a Responsible Federal Budget

TPC Takes the Tax Challenge with Income Tax Rates

Jan 23, 2010 | Taxes

We recently invited folks to take the spending challenge and show how they would close the budget gap without raising taxes (or alternatively, take the tax challenge and show the inverse). Our first contestant suggested cutting bureaucracy --  a good idea but one that doesn't get us too far.

Bob Williams, Rosanne Altshuler, Katie Lim of the Tax Policy Center took this challenge without even knowing it recently, in a  paper measuring what we would need to do on personal income tax rates in order to stabilize the debt.

So can we fix our budget problems with income tax increases? The short answer is no.

This is especially true if we only tax the rich. The authors looked at how high the top two rates would need to be to bring the deficit down to 2 or 3 percent of GDP if we kept other rates at their current levels -- as per the pledge that taxes not be raised for those making under $250,000 a year. In that case the top tax rate would need to increase to as high as 90 percent.

[chart:2058] 

Chart Created With Data From The Altshuler, Lim, and Williams, "Desperately Seeking Revenue."

And in reality, such high rates would almost certainly influence behavior and negatively imapct the economy; as a result, they would raise much less revenue than the authors' static analysis reflects.

So what about moving passed the $250,000 tax pledge? Well, if we raised each rate proportionally they would each have to go up by 40 to 50 percent -- so the bottom rate would have to increase from 10% to as much as 15%, and the top rate from 35% to around 50%. And again, these assume no behavior responses. 

[chart:2057]

And still, these taxes only get you to 2019. As the population ages and health care costs grow, the costs of Social Security, Medicare, and Medicaid are expected to rise considerably in the following decades. So tax rates would have to keep rising. 

Income tax rates can surely be part of the solution, but they fall short of being able to fix the budget problem on their own. An excelent place to look for new revenue would be the income tax base, which could be broadened by reducing the multitude of tax credits, deductions, exemptions, and exclusions.

Even then, depending on how much policy makers are willing to cut on the spending side, there may very well have to be a new source of revenue: likely contenders are an energy tax, transactions tax, or consumption tax.

If these taxes are considered, one of the most heated debates is likely to be over whether they should be introduced in place of the income tax, on top of it, or some combination. We'll surely write more on this in the future.

(If we decide it makes sense to raise income tax rates, here is a rough guide of home much we could raise per percentage point increase.)
 
 
 
Options
Revenue (billions)
 5-year10-year
Raise All Ordinary Rates by 1% $196$455
(Include AMT and Capital Gains Rates) $267$626
Raise Top 4 Ordinary Rates by 1% $81$200
Raise Top 3 Ordinary Rates by 1% $47$119
Raise Top 2 Ordinary Rates by 1% $39$99
Raise Top Ordinary Rate by 1% $29$74
Raise Rate by 1% for Income Above $1 million $17$45

Chart Created With Data From The Congressional Budget Office

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