Can we tame the budget without squeezing the middle class?

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  • Can we tame the budget without squeezing the middle class?

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  • Given how much money the top 1% has, couldn't taxing them do the trick? No.

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  • Like the other free-lunch myths, the claim that we need tax only the rich flies in the face of economic reality.

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In his latest New York Times Magazine column, Adam Davidson writes, "To solve our debt problems, we have to go to where the money is - the middle class."

To continue the discussion, we asked two economists on different sides of the debate - Jared Bernstein, former economic adviser to Vice President Joe Biden, and Alan Viard, who was a senior economist at the Council of Economic Advisers during the Bush Administration - to answer the following question.

"Like the other free-lunch myths, the claim that we need tax only the rich flies in the face of economic reality." --Alan ViardCan we get the country on a sustainable spending path without raising taxes or cutting benefits on Americans who make $30,000 to $200,000 a year?

The effort to tackle the United States' long-term budget deficit faces many obstacles - inertia, the power of special interests, and partisan gridlock. But the most insidious roadblock is posed by the false allure of easy and painless fiscal solutions. This siren call takes many forms: We need only cut waste, fraud, and abuse; we can raise revenue by cutting taxes; we can magically "bend the cost curve" in health care. Or, we need only raise taxes on a small number of rich people.

Like the other free-lunch myths, the claim that we need tax only the rich flies in the face of economic reality. The fact that the budget gap cannot be closed solely by taxing the rich has been recognized by economists and commentators across the political spectrum, including the editorial pages of the New York Times and the Washington Post, economists at the Urban-Brookings Tax Policy Center, and 2008 Nobel economics laureate Paul Krugman.

Many or all of these enthusiastically support tax increases on the rich as part of the fiscal solution, but they recognize that broader measures will also be necessary.

The Congressional Budget Office reports that households in the top 1 percent earned a resounding 19 percent of before-tax national income in 2007, up from 9 percent in 1979. Given how much money this group has, couldn't taxing them do the trick?

No. Even if the entire 19 percent income share could be taxed, an increase of 20 percentage points in marginal tax rates would raise less than 4 percent of GDP, not enough to close the long-run fiscal gap. And even that's not remotely possible. Part of this income has to be exempted to avoid an absurd jump in tax liabilities - if you don't tax people making less than $400,000, you can't tax the first $400,000 earned by someone making more than that. Moreover, steep hikes in marginal tax rates will give these households an incentive to report lower income.

Tax increases on the rich can be part of the fiscal solution, but not all of it. Several factors should shape our decision about whether and how to raise taxes on the rich.

Contrary to some recent claims, the rich, as a group, already pay higher tax rates than the rest of the population. In 2007, the top 1 percent, with 19 percent of national income, paid 28 percent of total federal taxes, including payroll taxes. Of course, they could afford to pay more - after making those tax payments, they still cleared a staggering $1.3 million per household.

Then again, taxing this group poses significant economic disadvantages, as they provide a large share of the nation's savings, which finance the investments that drive long-term growth. But some of the harmful economic impacts can be mitigated if the tax increases take the form of curtailing tax breaks rather than boosting rates. These trade-offs will ultimately be resolved through the democratic political process.

Free-lunch myths should not distract us from the challenge at hand. The fiscal imbalance must be addressed through a bipartisan agreement that includes broad tax increases and entitlement cuts.

Alan D. Viard is a resident scholar at AEI.

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