What do deficits mean? Part 1, taxes.

I want to write some responses to common comments I hear about economics. I’m no expert, but I’ve been reading a lot about this the last year or two, so I’m at least moderately well informed.

Let’s start with something very basic, the relationship between taxes and spending. I have been told that we need to cut government spending so that we can pay lower taxes and the American people can spend more money. While this may seem to make sense, taxes and spending don’t work that way. When spending increases nothing forces taxes up, and when taxes drop nothing forces spending down. The government needs to do those things independently. The deficit is the money we’re borrowing to cover the gap between the two.

The first thing we need to know is that taxes are extremely low right now. I’m sure some people will find this hard to believe, especially given the conservative claim that we have a spending problem, not a revenue problem. Lets start with the simplest measure, marginal tax rates.

tax rates chartThis is straightforward enough: while the country has had lower rates in the last hundred years, we’re currently very near the bottom in all categories. But marginal rates aren’t the whole story, there’s a lot more going on with deductions and such. So lets look at what actually gets paid. First, there are two important things to adjust for. We need to remove inflation to get a fair comparison. One dollar doesn’t mean what it did 30 years ago. Second, we need to compare how much tax revenue was lost with how much the economy dropped to see what is tax policy and what is just economic forces. The simplest way to achieve these is to look at tax receipts as a percent of the total economy.

tax receipts as percent of gdpWhat we end up with is tax revenues currently the lowest percent of our economy they’ve been since the 50s.

All of this is to say, simply, that taxes have gone down, not up since the recession began. Stimulus has gone into the deficit, not come out of the pockets of Americans. In fact a portion of the stimulus was tax cuts, contrary to popular belief. And likewise, cutting spending will reduce the deficit, but it won’t reduce taxes. What that means is that cutting spending will take money out of, rather than putting it into, the economy. The key here is that any money the government borrows it also spends, so cutting spending means taking money out of the hands of whoever was going to receive it.

Of course that begs the question, what about the national debt? Isn’t that doing more harm than cutting spending would? Big question, and I think this post is long enough. Part 2 coming later.

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