Washington, We Have a Revenue Problem
This piece is the first in a six-part series on taxation and a joint project by The American Prospect and its publishing partner, Demos.
The United States has a revenue problem. Taxes at all levels of government are too low to balance budgets and, more important, to ensure America’s future prosperity and cope with an aging population. While many political and policy leaders argue that future revenues should reflect “historic norms,” this is a flawed assumption on which to base long-term fiscal planning.
Tax revenues have accounted for around 18 percent of GDP since World War II, and 18.3 percent over the past 30 years. The budget released by Paul Ryan and the House Budget Committee proposes average revenue levels at this same level—18.3 over the next decade. (Although an analysis by the Tax Policy Center found that the average would in fact be 15.4 percent.) The Simpson-Bowles plan, released in late 2010, proposed average revenues of 19.3 percent through 2020. Meanwhile, the Obama Administration’s 2013 budget proposal sets revenues at 19.2 percent of GDP over the next decade.
All three of these proposals would provide inadequate funding to the federal government. Indeed, each creates a funding shortfall and continued deficits: Simpson-Bowles projects average deficits of 2.8 percent of GDP; the Obama budget, 3.3 percent; and the Ryan plan 1.7 percent. While deficit spending at such levels is acceptable, these numbers are testament to the simple fact that revenue levels at, or even slightly above, historical levels will lead to trillions of dollars in new debt over the next decade. By its own estimates, even the Ryan budget would add $4 trillion to the debt over the next decade—realistically, that figure would likely be much higher given the difficulty of making the deep cuts the Tea Party leader suggests.
Looking backward, we also see that “historic norms” of revenue over the past thirty years have been too low, which is why the federal government amassed $12 trillion in debt during this time. The only period, and it was fleeting, that the United States achieved a balanced budget was between 1999 and 2001, when taxes hovered around 19 to 20 percent of GDP for several years. The inability to get by on average revenues of 18.3 percent of GDP for the past 30 years is noteworthy because that period spans five different Republican and Democratic administrations and various configurations of partisan control of Congress. This period also included concerted efforts to cut or restrain federal spending, with this becoming an ostensible centerpiece agenda of the Republican Party, which controlled the White House for a majority of this time and both houses of Congress for about a third of this period.
In short, the federal government has raised too little revenue compared to the spending levels desired by both political parties. Even without the major challenges surely to come our way, the record points to an obvious need for higher revenues. An aging population and intensified global competition intensifies will only compound this need.
The Boomers Retire
There is no historical precedent for the graying of the U.S. population that will take place in coming years, which will put new strains on public finances—mainly at the federal level, but also at the state and local level. As the Boomers retire, the share of the U.S. population over 65 will increase from 13 percent today to 19.3 percent by 2030; the number of Medicare beneficiaries will rise from 47 million to 80 million.
The number of Americans receiving Social Security will rise by a similar magnitude, while the ratio of workers to each Social Security beneficiary will fall from 3.4 to 2.1. And because nearly half of all Baby Boomers have not saved enough for retirement, the pressure to maintain and expand Social Security benefits will be intense (as opposed to cutting such benefits, as some suggest.)
The aging population will also put huge strains on Medicaid, as the population of seniors living in nursing homes doubles or triples between now and 2030. A variety of smaller federal, state, and local-government programs that provide a safety net to low-income seniors will also need to be expanded. Overall, even with major reforms to control health-care spending and some reductions in current entitlement benefits, there is simply no way around the fact that the United States faces a hugely expensive demographic transition that will necessitate higher levels of public spending and revenue to match it.
Rising Global Competition
The United States is also in new terrain in terms of global economic competition. Leading rivals are making large-scale investments in human and physical capital, and failure to keep up—which has already diminished living standards for many Americans—would have profoundly negative ramifications. Reduced public investment has already put the U.S. at a disadvantage. The United States spends less on education, as a percentage of GDP, than a number of other countries in the Organisation for Economic Co-operation and Development (OECD), which tries to promote economic growth among its 34 member countries. Not surprisingly, we are falling behind in key areas. The U.S. now ranks behind the majority of OECD countries in the percentage of young workers who have degrees in science, engineering, and math, and also lags in the proficiency of school-age students in these areas. While the United States once led the world in the number of young workers with college degrees, it now ranks 12th among OECD countries.
The story is similar on infrastructure, another crucial foundation for prosperity. While China puts in thousands of miles of high-speed rail and builds the most advanced airports in the world, and while South Korea has achieved nearly universal broadband access, the United States spends less today on infrastructure as a percentage of GDP than it did in previous eras in which it faced much less economic competition. It lags behind other advanced countries both in how much it spends on infrastructure and the sophistication of its transportation systems. According to one recent study, the U.S. needs to spend $2 trillion just to repair maintain its deteriorating infrastructure. To spent as much on infrastructure as the average among countries in the European Union would require several trillion dollars in additional spending over the next decade.
Public Expectations of Government
What’s also different about today is that Americans have expansive expectations of government. Although polls show that the public distrusts government, and believes that much public spending is wasteful, Americans strongly back the most expensive programs, Social Security and Medicare. Majorities of the public oppose drastic cuts to these programs. Medicaid, commonly seen as less popular, also commands strong support when Americans understand how large a share of spending on this program goes to support seniors in nursing homes.
The public is enthusiastic about other areas of government spending as well. Large majorities support spending on education, veterans, food safety, air-traffic control, parks, and space exploration. In general, Americans also favor a strong military and national-security establishment. The areas of government that the public dislikes, most notably foreign aid, account for a very small fraction of government spending.
Higher Revenues Also Needed at the State and Local Level
It’s not just the federal government that will need to raise and spend more money in coming decades; it is also state and local governments. Indeed, spending at this level is arguably more crucial to our future prosperity. In the fiscal year 2012, state and local governments spent a combined total of $3.1 trillion, an amount equal to the federal total when one takes into account the $580 billion that the federal government transferred to states and localities. A large share of state and local spending is what can be called “social capital”: investments in the very things that will help fuel future growth, such as education, housing, transportation infrastructure, and parks. Seventy-five percent of all spending on transportation and water infrastructure is by state and local governments and 90 percent of K-12 education spending is by state and local governments.
What’s alarming, though, is that state and local social capital spending has declined over the past 15 years, primarily because of a revenue crunch. While aggregate state and local revenue has remained largely unchanged as a percentage of GDP since the 1990s, state and local “non-social capital spending”—health care, pensions, and debt—has been increasing rapidly over the past 15 years, causing the share of spending devoted to social capital to decline. If state and local government spent the same percentage of their budgets on social capital investments in 2009 as they did in 1996, they would have spent $187.6 billion more on the building blocks for our future prosperity. The fiscal crisis that beset the states has exacerbated this situation, but this is a long-term trend.
The levels of future tax revenues envisioned by most political leaders in Washington and state capitals are certain to be inadequate given new challenges facing the United States. Much higher revenues will be needed if the nation wishes to stay economically competitive in a globalized economy and offer basic security to the largest generation of retirees in its history. Controlling health-care and pension costs and other kinds of spending—particularly defense—is imperative, but even substantial savings in these areas will not forestall the need for higher revenues levels than most political leaders now wish to contemplate.
What levels of revenue will actually be needed? Revenues would need to be 22 percent of GDP on average over the next decade just to achieve fiscal balance under either the Simpson-Bowles or Obama Administration budget plans, both of which cut spending in important areas. Avoiding deep cuts and actually increasing public investment in the foundations of prosperity would require federal tax revenues closer to 24 percent of GDP. Meanwhile, revenues at the state and local levels would also need to rise. All told, the United States may be looking at combined federal, state, and local revenue needs in the range of 40 percent of GDP during coming decades as the Boomers retire, depending upon how much debt is considered acceptable.
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