– December 13, 2017

Contrary to the official selling points, the Republican tax reform is not primarily a plan to help the US economy grow. It is equally concerned with maximizing tax revenue; in fact, when the goals of stimulating growth and collecting tax revenue collide, the reform tends to prioritize tax revenue. Its preference for securing tax revenue is so strong, in fact, that it reinforces the progressive profile of the personal income tax code. Under some conditions the Senate version creates marginal-tax effects in excess of 100 percent.

With the federal government debt exceeding GDP, it is understandable that congressional Republicans want to get deficits under control. After all, the US government still has not recovered from the credit downgrades it suffered under President Obama’s first term.

There is just one problem: it won’t work. Reforming taxes to reduce, or even control, the budget deficit is like a cat trying to catch its own tail. Deficit reduction will require major, structural spending reform, an item that is notably absent from the GOP legislative agenda.

There are several reasons why the tax reform, like the tail-chasing cat, will not succeed. For one, the tax increase discourages growth and therefore erodes the base for future tax revenue. However, of more immediate concern is the fact that government borrowing is so significant, and has been around for so long now, that it has effectively become a permanent third arm of government funding (in addition to taxes and fees).

To understand the depth of the deficit problem, one has to go beyond the federal budget. The public discourse suggests a widespread realization that the federal government has a chronic deficit problem. With the exception of four years under President Bill Clinton, the federal budget has been in the red since the late 1960s. However, the federal budget only represents part of government spending: states and local governments are responsible for almost 39 cents of every dollar in government spending.

Sadly, states and localities are almost as good as the federal government at relying on deficits to pay for their spending. While deficits are of varying importance across the country, in the aggregate, states and local governments have been over-spending consecutively since 1990 (again with the exception of four years under Clinton).

For those who are not scared by harsh fiscal realities, the sum total of federal, state, and local government deficits make for a stunning image. Figure 1 reports the consolidated budget balance for all levels of government in the United States, as percent of total government spending:

Figure 1

Source: Bureau of Economic Analysis

In 2016, all levels of governments spent a total of $6.7 trillion, yet total revenue only amounted to $5.8 trillion. The federal government is directly responsible for 81 percent of the $900 billion gap.

In practice, though, Congress is responsible for more than that. State and local governments get 23 percent of their revenue from Congress under the label “federal aid to states.” To keep that cash coming, states have to spend some of their own revenue as “maintenance of effort.” For example, in Medicaid many states have to add 50-60 cents to every dollar they receive from the federal government, or lose Medicaid funds altogether.

When federal aid and maintenance-of-effort spending are added together, the federal government directly or indirectly controls at least one third of state and local government spending. This fiscal control over lower governments forces spending that, in many states, goes beyond what their taxpayers can afford.

Which brings us back to the Republican tax reform. Even if one ignores the growth-discouraging effects of the reform and assumes that it will indeed secure revenue as planned, it is entirely unrealistic that it could eliminate $900 billion in deficits. To tackle that problem, Congress needs to take an entirely different route. Is it too much to ask for that Republicans on Capitol Hill give the totality of welfare-state spending the same attention they have just given the taxes that pay for all that spending?

Image: Paul Ryan.

Sven Larson, PhD

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