The dramatic economic decline because of the COVID-19 crisis and the unprecedented recovery spending plans approved by President Donald Trump will drive the fiscal 2020 U.S. budget deficit to a record $3.8 trillion, or almost 19 percent of U.S. gross domestic product, according to the Committee for a Responsible Federal Budget.
According to the same estimates, the 2021 fiscal deficit would reach $2.1 trillion in 2021, and average $1.3 trillion through 2025 as the economy recovers from the effects of the forced shutdowns.
To finance this staggering fiscal effort, presumptive Democratic presidential candidate Joe Biden has proposed a massive tax increase that will neither help the economy nor reduce the deficit.
The solution to the U.S. budget deficit isn’t more taxes. Even in the most optimistic receipt scenario, there’s no tax hike program that would even start to address the structural deficit, estimated at $1 trillion a year, even less with the above-mentioned estimates.
More taxes will hurt the recovery, damage the job improvement potential, and reduce investment in the economy. More taxes mean less growth and no deficit improvement.
The Obama administration learned this lesson quickly, and extended the Bush tax cuts in 2010, adding a new tax cut in 2013. Other U.S. misguided tax increases in 2013 did nothing to reduce the debt and kept the economic and job growth below potential.
A wealth tax, often repeated by the most extreme politicians in America, would not only provide exceedingly small revenues for the Treasury, it would generate more negatives than any improvement in tax receipts. There’s a reason why almost every European nation has abandoned the wealth tax. The receipts are negligible and the negative impact on investment, attraction of capital, and job creation outweigh any revenue increase.
The wealth tax revenue relative to GDP in countries where it exists ranges between 0.2 percent in Spain to 1.3 percent in Switzerland. There’s no way that a wealth tax would collect 1.4 percent of GDP as Sen. Elizabeth Warren (D-Mass.) estimated. A wealth tax in the United States would make no visible reduction to the existing deficit, let alone finance the trillions in entitlement spending that Biden has announced.
So, how can the United States reduce the deficit?
The U.S. deficit is rising due to excessive spending increases, despite periods of rising tax receipts. The federal government’s revenue went up by 4 percent, to $3.46 trillion in the 2019 fiscal year, according to a Congressional Budget Office (CBO) report. However, spending went up by more than 8 percent, to $4.45 trillion.
The rise in 2019 deficit was not due to the “tax cuts.” If anything, the tax cuts helped the economy stay in expansion, creating jobs and increasing receipts at the same time. Corporate income taxes increased by $25 billion (+12 percent), while individual income and payroll taxes together rose by $106 billion (+4 percent). Overall, total receipts rose by 4 percent ($3,462 billion in the fiscal year 2019). Total receipts remained at 16.15 percent of GDP, which is the long-term trend figure and consistent with an economy that remained in expansion with moderate growth.
The main problem is that total outlays rose by 8 percent (to $4,447 billion), driven mostly by mandatory expenses in Social Security, Medicare, and Medicaid.
Those who say that the deficit would have been solved by eliminating the Trump tax cuts have a problem with mathematics. There’s no way in which any form of revenue measure would have covered a $339 billion spending increase.
No serious economist can believe that keeping uncompetitive tax rates well above the average of the Organisation for Economic Co-operation and Development (OECD) would have generated more receipts. Furthermore, no serious economist can believe that eliminating the Trump tax cuts would have generated more than $300 billion of new and additional revenues.
Remember that corporate tax receipts already fell 1 percent in 2017 and 13 percent in 2016, before the Trump tax cuts. The operating profit recession was already evident. If anything, reducing the corporate rate helped companies recover, which in turn made total fiscal revenues rise by $13 billion to $3,329 billion in the fiscal year 2018, according to the CBO.
The problem of the U.S. budget is mandatory spending.
Mandatory spending was $2.7 trillion out of a total of $4.45 trillion outlays in fiscal year 2019. This figure is projected to increase to $3.3 trillion by 2023. Even if discretionary spending stays flat, total outlays are estimated to increase significantly above any advance in tax revenues.
Printing money hasn’t reduced deficits or debt. The Federal Reserve has increased its balance sheet to record-highs, on its way to $10 trillion, and purchasing Treasuries has only driven governments to continue to spend above budget and the trend of receipts.
Furthermore, if proponents of massive money printing tell us that deficits don’t matter and that the U.S. government should spend all it needs because the Fed will acquire all the debt, then there’s no need for higher taxes, is there? In fact, if Modern Monetary Theory (MMT) proponents were right, taxes should be cut, and deficits monetized to drive the recovery.
The problem is that the magic money tree doesn’t exist. Monetary policy is only disguising a structural and dangerous spending problem, and this reckless behavior can only be maintained if the U.S. dollar remains the world reserve currency. Therefore, not only is there a limit to how much the Fed can print, there’s also a risk that if governments don’t reduce spending, the United States may lose its world reserve currency status.
Consequently, the only solution for America to reduce debt is to cut spending and entitlements.
Any politician should understand that it’s simply impossible to collect an additional $3 trillion per year over and above the existing receipts. They should also understand that the trust in the U.S. dollar may collapse if deficits continue to balloon.
It’s completely impossible to double the receipts of a growth year such as 2019 with higher taxes. Higher taxes will only wreck an already weak economy and delay the recovery. It’s completely impossible to reduce deficits by printing money. Governments will only increase spending if they can monetize it at the expense of real wages and savings.
Believing that the deficit can be reduced by massively hiking taxes isn’t understanding the U.S. economy and the global situation. It would lead to job destruction, corporate relocation to other countries, and lower investment. Believing that the deficit will be reduced by printing money is not understanding the perverse incentives of governments.
The proof that the U.S. problem is a spending issue is that even those who propose massive tax hikes aren’t expecting to meaningfully cut the deficit, even less so reduce the debt; that’s why they add massive money printing to their magic solutions. It won’t work either. And this reckless policy may destroy the U.S. dollar’s reserve status.
Debt matters, even if interest rates are low. Increasing debt and spending means lower growth and weaker real wages in the future.
Daniel Lacalle, Ph.D., is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.