America’s Fiscal Armageddon And How To Avoid It, Part 4

In Part 3 we suggested that a federal tax policy targeted on generating revenue equal to 19.5% of GDP could produce receipts of about $67.0 trillion over the next decade or about $4.4 trillion more than the existing CBO baseline estimate of $62.6 trillion.

The latter, of course, reflects current tax law, which would extract about 17.8% of national income in Federal taxes over the period. So the question recurs: How can we obtain an extra 1.7% of GDP in taxes each year without causing undue hardships, unfairness and roadblocks to private sector investment, incentives and growth?

The honest answer is you probably can’t because all taxes—especially from current high levels—cause hardships, inequities and disincentives. But the $140 trillion of public debt that America is careening toward by mid-century would have far worse adverse effects. So the practical challenge is to find the most economically neutral way possible to achieve a $4.4 trillion revenue contribution to an overall fiscal retrenchment plan that would reduce cumulative deficits by $14 trillion or more than two-thirds over the coming decade.

In that context, we focus on the yawning gap between what the Federal individual and corporate income taxes would generate on an economically neutral basis, and what the current loophole-ridden and interest group-corrupted tax code actually generates.  That is to say, the top rates on personal and corporate income are 37% and 21%, respectively, but in combination these two systems generated tax revenues equal to just 9.7% of national income in 2023.

Accordingly, on a 10-year forward basis here is the current baseline level of receipts, and the impact of reaching the 19.5% of GDP revenue target by closing loopholes and broadening the taxable income base.

Cumulative Federal Receipts, 2025 to 2034:

• CBO estimate of individual income taxes: $33.0 trillion.

• CBO estimate of corporate income taxes: $5.1 trillion.

• Total Federal Income Taxes: $38.1 trillion.

• Incremental receipts from 19.5% target: +$4.4 trillion.

• Percent Federal Income tax increase: +11.5%.

Needless to say, an 11.5% increase in Federal income tax collections is nothing to sneeze at. Yet when you examine the US Treasury’s latest analysis of so-called Federal “tax expenditures”, which are defined as the revenue loss from tax code deviations from economic neutrality, it is evident that there is substantial opportunity to broaden the Federal tax base while retaining the current relatively modest marginal rates (10%, 12%, 22%, 24%, 32%, 35%, 37%).

Specifically, the Treasury analysis for FY 2023 to 2034 identified tax expenditures of $21.4 trillion over the period. During the same decade interval, the CBO baseline estimate for individual and corporate income tax collections was $34.7 trillion, meaning that the implied economically neutral tax base would have generated $56.1 trillion. Taken as a whole, therefore, the current tax expenditures and loopholes reduce Federal tax collections by 38%.