Enjoy Stimulus Now, Pay Your $14,000 Share Later

How will this year's colossal budget shortfall, fueled by the deteriorating economy and amplified by stimulative fiscal policy, affect the individual taxpayer? Taxpayers will eventually be required to foot the bill for this year’s record-setting deficit, so they should not be surprised to find substantial tax increases in their future.

Senior Fellow
Kevin A. Hassett

As bad as the news has been this year, for taxpayers there is much worse news to come.

Economists who study fiscal-policy history divide the world’s governments into two categories. There are the so-called Ricardian governments, which wisely plan their taxes and spending so that they balance over time. Then there are the Nonricardian governments, which spend and borrow until they collapse.

Ricardian governments borrow in bad times and lend in good. Nonricardian governments look like a Madoff investment pool and borrow themselves into oblivion.

The category names refer to the 19th-century economist David Ricardo, who pioneered the study of government finance. His ideas have such resonance that they continue to animate one of the hottest corners of economics.

The bottom line from the latest work is simple: economies of Nonricardian governments can malfunction in bizarre ways. If capital markets lose faith in a government’s long-run commitment to fiscal discipline, it’s the economic equivalent of a meteor strike.

Markets expect U.S. taxpayers to pick up the bill for this mess. Anything else would be unthinkable.

But oh, what a bill it will be.

Dream On

When the stimulus package, the SCHIP expansion and whatever else our representatives in Washington dream up are on the books, it seems likely that the deficit for this year will approach $1.7 trillion. This is an enormous swing in the U.S. fiscal condition.

Under President George W. Bush--a big spender in his own right--the federal budget deficit reached a record $455 billion in fiscal 2008, more than double a year earlier. Government bailouts of banks and other industries that started under Bush, and may accelerate under President Barack Obama, will help push the deficit toward that $1.7 trillion mark.

That is $1.7 trillion in future taxes. Nobody knows exactly when the tax hike will come. It might even be that we shall try to foist the costs on our children. Still, those planning their financial futures should account for the dramatically higher taxes that will be the result of this year’s policies.

Check the Numbers

Suppose the government eventually decides to allocate the bill according to the latest distribution of taxes. In 2006, for example, people with incomes between $50,000 and $75,000 paid about 10 percent of all income-tax revenue. As a thought experiment, how much would those people’s taxes go up if Uncle Sam raises 10 percent of $1.7 trillion from them?

If you run the numbers for that and other income brackets, you’d better sit down. Our spending policies are not digging a hole, they are conjuring up a Stygian abyss.

If your family income in 2006 was between $75,000 and $100,000, the extra taxes that you will have to pay at some point in the future add up to about $14,000.

If your income was between $100,000 and $200,000, your future tax hike will be about $28,000. If your income was between $200,000 and $500,000, then your future tax bill just went up by $90,299.

Everybody Pays

While our tax system is heavily tilted against the rich, even those with relatively low incomes will eventually have to pay. The extra tax bill for someone with 2006 income between $25,000 and $30,000 will be about $2,500.

These numbers are in present value. If government puts off sending you the bill--and thus must pay interest between now and then--the bill will be higher. How much higher? If the government waits 10 years to collect the $14,000 from the person with income between $75,000 and $100,000, the bill a decade from now will be about $22,800.

To put these numbers in perspective, suppose that the U.S. government decided that it was going to stimulate the economy by ordering individuals to purchase stuff. Ever attentive to distributional issues, this mandatory purchase program would require less of poorer individuals.

A government program with about the same distributional consequences as this year’s fiscal policy would require a person with an income between $25,000 and $30,000 to buy a really nice 52-inch flat-panel television. Those with incomes between $75,000 and $100,000 would be required to purchase a brand new Chrysler PT Cruiser. Those with incomes between $200,000 and $500,000 would have to purchase a midsize recreational vehicle.

Keep It

The difference between this hypothetical program and what we got, of course, is that in the hypothetical, at least you get to keep the stuff.

These tax bills are also large relative to the typical wealth of individuals in most income brackets. For example, recent Federal Reserve data suggest that the typical person with income around $100,000 has about $300,000 in assets. The new tax liability associated with this year’s policies is a little less than 10 percent of their wealth.

So when you get your tax rebate in the mail after the stimulus package becomes law, do yourself a favor and put it in the bank. Given the big tax hike that is coming, anything else would be irresponsible.

Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.

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