The Case for Bigger Government

(2 of 3)

Here's the problem with that math: the tax system brings in about 18% of GDP, less in a recession — and Obama is even floating a two-year, $300 billion tax cut (roughly 1% of GDP per year). Even worse, our federal revenues are nearly exhausted by just four areas of spending: Social Security and other retirement programs, health programs such as Medicare and Medicaid, defense, and interest payments on the public debt. Almost all the rest of our expenditures — from education and infrastructure to international diplomacy and much more — have to be funded by borrowing. We are racking up trillions of dollars in debt, to be paid in the future through taxation or inflation, in order to carry the year-in, year-out responsibilities of government. 

There are certainly some straightforward ways to start closing the budget gap. The Bush tax cuts for the rich should be rolled back this year, not next, to start collecting about 0.5% of GDP in extra revenues from those who can most easily pay, though this might just partly offset other tax cuts and recession-induced declines in tax collections. The spending on the wars in Iraq and Afghanistan should be ended, not prolonged, saving at least 1% of GDP. We'd still probably be close to $1 trillion (perhaps 6.5% of GDP) shy of budget balance. With the economy in a tailspin, deficit financing of up to $1 trillion could make sense, but it's a fleeting option because foreign nations have lost confidence in the U.S. economy and currency. 

Instead, we will have to look for a variety of solutions. Infrastructure can be financed in part by borrowing against future user fees, like tolls on roads and higher electricity rates for more reliable and cleaner power, rather than against general government revenues. This strategy can probably cover as much as 1% of GDP per year. We can introduce new taxes on the carbon emissions from coal, oil and gas to hasten our transition to sustainable energy. For example, instead of letting gasoline prices tumble now only to see them soar again shortly, we could set a floor on prices at the pump and collect the difference between the wholesale and retail prices in federal revenues. Various carbon and gasoline taxes could raise another 1% or so of GDP. The public will also probably accept taxes on health care if they convincingly help save even more in private outlays on health insurance. A well-managed system of public financing of health care can do that and allow us to cut the horrendous sums paid to health-insurance companies. And in the end, though almost no U.S. politician will say it now, the U.S. will probably have to follow Europe down the path of the value-added tax — a kind of national sales tax. 

In the past 50 years, arguing for tax increases to fund the expansion of federal programs has been a political death wish. Lyndon Johnson could not sell the public on tax increases to pay for his War on Poverty when the Vietnam War intruded. Jimmy Carter failed to close the deficit through higher taxes in the late 1970s. And Ronald Reagan made tax cuts the down payment on every election since. George W. Bush, of course, imitated Reagan in cutting taxes, thereby creating huge new budget deficits. Voters are still willing to permit the government to expand its share of GDP, particularly in the face of national crises — and we are certainly in the middle of one. Tax revenues jumped from just 5% of GDP in 1936 to 15% to 20% during and after World War II, creating our modern tax system. At the end of the war, the level of federal taxation averaged around 18% of GDP, a rate that has remained nearly constant ever since. 

What has changed is the way we spend that 18%. In the 1950s, during the Korean War and at the height of the Cold War, about 10% of GDP was devoted to defense. Over time, that share of spending on defense declined, making room for proportionally more spending on things like health care, education and infrastructure. By the late 1970s, as defense spending declined to 4% to 5% of GDP, there wasn't a lot more room to squeeze defense for higher domestic spending. Even with the end of our current wars in Iraq and Afghanistan, it's most unlikely that we'd save as much as 2% of GDP, given the vocal demands for increases in military budgets.