Tax Threats Ahead

Chris Edwards

The Democratic presidential contest is revving up the tax policy debate. The candidates are calling for higher taxes on corporations, capital gains, wealth, and much else. In the second round of debates, New York Mayor Bill de Blasio said he wants to “tax the hell out of the wealthy,” and that is a common sentiment in his party these days.

The tax issue had faded after Republicans passed their Tax Cuts and Jobs Act in 2017. Most people did not notice they received a tax cut, and Republicans have been lousy salespersons for their reform.

Going forward, taxes will reclaim center stage, but rather than tax cuts, there could be endless battles over tax hikes. Today’s surfeit of soak-the-rich ideas from Democrats may be just a prelude to major thrusts at hiking middle-class taxes down the road.

The tax threat is rising because federal debt is piling up by more than $1 trillion a year. If growing debt triggers a financial crisis, government interest costs may spike, which could prompt Wall Street to press Washington to raise revenues.

During the financial crisis a decade ago, politicians responded rashly with bailouts and wasteful stimulus measures. But federal debt has more than doubled since then, so when the next crisis hits the politicians may rashly decide that a tax hike is needed to calm financial markets, which has been the response to debt crises in other countries.

Another harbinger of tax hikes is the abdication of spending restraint by Republicans. The current two-year budget deal will add another $1.7 trillion to spending over the coming decade. On paper, control of Congress is split, but in practice the spend-more-on-everything party dominates.

The disinterest in spending restraint by President Trump and the Republicans is setting up the 2020s to be the tax-hike decade. All the experts say that rising debt is “unsustainable,” and that means the gap between spending and revenues will have to be contained at some point.

As for the Democrats, they have moved hard left and favor large-scale federal expansion, not restraint. Whereas President Obama signed the 2011 Budget Control Act to limit spending, today’s Democrats are proposing huge new outlays on green energy, health care, and many other things.

To fund an expanded welfare state, Democrats are pushing three broad tax planks. First, nearly all the presidential candidates want to repeal the TCJA’s tax cuts. The law’s individual cuts expire after 2025, and Democrats will have the upper hand in letting them go because deficits will be running $1.5 trillion or more at that time.

Second, the presidential candidates are proposing a slew of tax increases, including higher taxes on corporations, capital gains and estates. Sen. Elizabeth Warren (D-Mass.) has proposed an annual wealth tax, and a number of candidates want new taxes on financial trades.

Those are all taxes on capital, which Democrats believe won’t hurt labor. But they are wrong because when taxes on capital rise, investment falls, workers are less productive, and wages stagnate. For the government, tax hikes on capital would backfire because they would induce more avoidance and undermine growth, thus suppressing overall federal revenues.

On the spending side, Democrats will likely continue tag-teaming with the GOP to expand defense and domestic programs, thus pushing deficits ever higher. A paid-leave entitlement could be the next bipartisan budget-buster.

And that brings us to the third tax-hike plank. As spending expands, the search for new revenues will intensify, leading to a push for new, broad-based taxes on the middle class. The leading candidates for this nightmare scenario are a carbon tax and value-added tax (VAT).

Both carbon taxes and VATs would be federal money machines because they have broad bases and would hide the burdens in the prices of goods and services. The politicians would say the taxes are imposed “on business,” but the costs would land on all of us.

Carbon taxes have gained support from economists, environmentalists, and numerous presidential candidates. How much would such a scheme cost? A middle scenario from the Tax Policy Center found that a carbon tax would about raise about $250 billion per year, or about $2,000 on every U.S. household.

A VAT would be an even more powerful revenue machine as it would land on most items we all buy. Democrat presidential candidate Andrew Yang is pushing a VAT, as have many economists and policymakers over the years. To Democrats, the political logic of a VAT may become irresistible because the huge revenues could fund new social programs while shoring up the financing of existing bloated entitlements.

Yang says his 10 percent VAT would raise $800 billion a year, or $6,300 per U.S. household. But once a VAT was in place, the politicians would push the rate higher, as we see in Europe where the average rate is 21 percent. The Euro VATs raise an average 7 percent of gross domestic product, which for the United States would be about $11,000 per household.

The expansive European welfare states that American liberals admire are not funded by taxes on the rich but by heavy taxes on everyone through VATs. Going that route would be a crushing blow to American freedom. Washington already controls our lives through 2,300 distortion-causing subsidy programs. Giving the politicians more fuel for welfare-state expansion would be a terrible mistake.

The only way to avert a dystopian high-tax future is large spending cuts. The Washington Post reports that President Trump “has instructed aides to prepare for sweeping budget cuts if he wins a second term in the White House.” That seems unlikely, but it provides more hope than anything coming from Democratic candidates or leaders of either party on Capitol Hill these days.

Chris Edwards is director of tax policy studies at the Cato Institute and editor of www.DownsizingGovernment.org.