House Budget Committee chairman Paul Ryan’s budget plan has been the talk of Washington this week. Most of the discussion has revolved around his proposal to privatize Medicare and slash many federal programs to the bone. Less attention has been paid to the tax side of Ryan’s plan, which is every much as radical as the spending side.
One would think that a comprehensive budget proposal designed primarily for the purpose of reducing budget deficits and the national debt would put at least some of the burden on the revenue side of the equation. First, it would reduce the need to cut spending so heavily and improve the chances of passage; unless Ryan is only interested in scoring points with the Tea Party crowd, he will need the support of at least some Senate Democrats and President Obama if he wants any aspects of his plan enacted.
Second, Ryan’s plan puts an exceptionally heavy emphasis on cutting programs like Medicaid and food stamps that primarily aid the poor, while the well-to-do are essentially held harmless because they don’t benefit much from federal spending. The one government spending program that arguably benefits the wealthy disproportionately is national defense because, as UCLA economist Earl Thompson has argued, it protects their capital. And that’s the one major program Ryan lets off the hook almost completely.
For Ryan, it is an article of faith that federal revenues must never rise above 19 percent of the gross domestic product no matter how dire the nation’s debt problem. No explanation for this necessity is offered in his plan, other than observing that the historical range of federal revenues as a share of GDP has been between 18 percent and 19 percent of GDP during most of the postwar era. Ryan simply asserts, without evidence, that this range is the one most compatible with prosperity.
Conservatives dogmatically believe that taxation is the single most important factor in economic growth, and the lower taxes are the better. But if that were the case, then the late 1990s should have been a period of exceptionally slow growth: Federal taxes averaged 19.9 percent of GDP from 1997 to 2000. In fact, that period was among the most prosperous in American history, with real GDP growing an average of 4.5 percent per year. By contrast, during the last four years, federal revenues have been exceptionally low, averaging just 16.5 percent of GDP. But growth averaged less than 1 percent per year.
Ryan Cites Letter from the CBO
Of course, there are many factors that affect economic growth. Economists universally agree that the major factor in long-run growth is technological advancement, and in the short-run the Federal Reserve’s monetary policy dominates. Taxes play a role, but so do a lot of other things, including federal budget deficits, which can reduce growth by raising real interest rates and crowding private investors out of credit markets.
In his plan, Ryan sets up a straw man by implying that the only alternative to his proposal is to raise tax rates. He cites the Congressional Budget Office as saying that the tax rates necessary to sustain the nation’s current fiscal trajectory “would end up sinking the economy.” But the report Ryan cites a letter to him from the CBO responding to a request by him to calculate the impact of reducing future deficits solely through marginal tax rate increases, with no spending cuts at all – something no one is proposing. While the CBO did indeed find that this would be harmful to growth, it also pointed out that alternative methods of raising revenue, such as broadening the tax base, would have substantially less negative effects on growth.
Ryan’s plan pays lip service to base broadening, but mentions no specific tax credits or deductions he would eliminate. That’s because the largest tax expenditures are things such as the exclusion from income of employer-provided health insurance, the deduction for mortgage interest, and the deduction for contributions to 401(k) pension plans that are very popular, politically. When asked by Time magazine to name a single tax preference he would get rid of to broaden the base, Ryan refused to do so, saying it was up to the House Ways and Means Committee to figure it out.
Ryan’s aversion to intruding on the turf of the Ways and Means Committee would be commendable if he hadn’t specified that his budget plan would require cutting the top corporate and individual income tax rates to a maximum of 25 percent. When the CBO analyzed Ryan’s plan, it could not confirm that his tax proposal would in fact raise the 19 percent of GDP he claims it would. That figure was simply asserted by Ryan’s staff. An analysis by the Tax Policy Center of an earlier Ryan proposal similar to this one, which Ryan also asserted would raise 19 percent of GDP in revenues, found that it would raise just 16.8 percent of GDP in revenues.
Crunching the Numbers
Ryan got around this problem by ignoring the Joint Committee on Taxation, Congress’s official revenue-estimating agency, and instead asking the ultra-conservative Heritage Foundation to crunch the numbers for him. Its analysis says that economic growth would be so extraordinary from enactment of the Ryan plan that the unemployment rate would fall two full percentage points next year alone, and continue to fall to less than 3 percent by 2020 – a level not seen since 1953. This massively higher growth leads to higher federal revenues – $58 billion more next year alone over those that would be collected without the Ryan plan.
A number of respected public finance economists quickly ridiculed the Heritage numbers as grossly implausible. MIT economist Jonathan Gruber said, “The Heritage numbers are insane.” In response to such criticism, Heritage simply deleted some of the more extravagant figures from its analysis.
Distributionally, the Ryan plan is a monstrosity. The rich would receive huge tax cuts while the social safety net would be shredded to pay for them. Even as an opening bid to begin budget negotiations with the Democrats, the Ryan plan cannot be taken seriously. It is less of a wish list than a fairy tale utterly disconnected from the real world, backed up by make-believe numbers and unreasonable assumptions. Ryan’s plan isn’t even an act of courage; it’s just pandering to the Tea Party. A real act of courage would have been for him to admit, as all serious budget analysts know, that revenues will have to rise well above 19 percent of GDP to stabilize the debt.