The Gang of Six Disaster

James C. Capretta at National Review Online:

In a nutshell, the Gang of Six plan would have three parts. Let’s look at each part in turn.

First, there’s a relatively small bill to supposedly save $500 billion immediately with a combination of discretionary spending caps through 2015

500 Billion is literally a joke. You should laugh at this. We’re in debt $14.5 trillion. Our annual deficit right now is about $1.5 trillion. So cutting 500 Billion over the next four years will knock about 8% off the deficit each year.

The second part of the Gang of Six package is far worse. It’s essentially a call for a budget “reconciliation” bill, with no specifics yet available. Senate committees with jurisdiction over taxes and entitlements would be tasked with achieving targeted amounts of savings or tax increases. For instance, the Finance Committee would be charged with reporting out a tax-reform plan that increases taxes by about $2.3 trillion over a decade.

…

Then the Senate would move on to the third part of the Gang of Six proposal: a Social Security reform package that closes the long-term financing gap. Again, with Democrats in control of the Senate and the writing of legislation, this almost certainly would mean another large tax increase.

There’s another glaring problem with this dumb proposal from the Gang of Six.¹ It assumes the U.S. economy is a bottomless pit of tax revenue. What’s to say we even have the ability to raise revenue to the government? Taxation has one guaranteed effect: it depresses economic activity. No matter where you look, there is a causal effect between raising taxes, and depressing the activity being taxed.

At some point, an incremental increase in taxes results in a decrease in revenue. This is because the additional tax money collected on each occurence of the taxable activity is offset by a lower number of taxable activities. That is, less activity occurs because it is less worth it for the individuals engaging in that activity. Once you reach this point, each incremental increase in tax rates results in a decrease in total tax revenue.²

Let’s look at an example. Pretend you have a 40 hr/week office job. You make $40,000/yr and you’re up for a promotion, which would raise your salary to $60,000/yr, but your schedule would extend to 55 hours a week. If that bumps you up to the next tax bracket, you’re going to weigh your options. Of the $20,000 increase, if you pay $5,000 in additional income tax, you may decide it’s worth the extra responsibility. If you pay $12,000 in additional taxes, that extra responsibility for only $8,000 more take-home looks a lot less attractive.

In this way, raising tax rates depresses economic activity. People who are normally motivated to excel to achieve a reward, are naturally less motivated by that reward if they have to give more of it to the government. The effect is that productive individuals are motivated more by their need to survive than their desire to excel, resulting in lower output for the individual.

If this plan passes (which, fortunately is pretty unlikely). I guarantee we will be in this same situation next year or the year after and the supposed experts would sit around scratching their heads trying to figure out why we still aren’t pulling in enough revenue. I’ll say it again: we don’t have a revenue problem, we have a spending problem.