Taxes Are Low--For Now

The temporary drop in tax collections has resulted in record budget deficits.

Americans filing their tax returns on April 15 may be surprised to learn that Tax Freedom Day--the day, calculated by the Tax Foundation, that America has worked enough to cover all its tax obligations for the year--already passed last week, on April 9.

That’s the earliest it has fallen since 1965, meaning the share of American income going to federal, state and local taxes--27%--is the lowest it’s been in more than 40 years. The drop is driven by the recession (which lowered tax revenues even faster than it lowered income) and by temporary tax cuts included in the stimulus package passed last year.

But don’t celebrate too much--the drop in tax collections is temporary, and has resulted in record budget deficits. Fast-growing federal programs (especially Medicare and Medicaid) and the need to close budget gaps will put sharp, upward pressure on taxes in the coming years.

President Obama has exacerbated this trend with several spending initiatives--the stimulus package, expansion of the Children’s Health Insurance Program, and now health reform--that have further increased the size and cost of government.

Indeed, while the stimulus included near-term tax cuts, President Obama has already gotten the ball rolling on tax increases to pay for expanded government:

--Not 100 days into his term, he broke his pledge not to raise taxes on the middle class when he enacted a 60-cent-per-pack rise in the cigarette tax.

--He has declared his intention to let part of the Bush tax cuts expire in 2011.

--The recently enacted health care law brings a stream of tax increases on everything from high incomes to insurance premiums to tanning, which will go live periodically from July of this year through 2018.

--And the President’s Commission on Deficit Reduction is likely to recommend further tax increases when it reports its findings next year.

Many of these tax increases will fall principally on high-income people. But high income tax increases--even those proposed by liberals in the House of Representatives, willing to go farther in soaking the rich than the Senate--won’t raise enough revenue to close the long-term budget gap.

For this reason, the middle class will bear much of the burden of rising taxes. We’re seeing this already--higher taxes on cigarettes, tanning and health premiums will not fall mostly on the wealthy. And senior Democratic officials, including Paul Volcker and Nancy Pelosi, have been floating trial balloons about bringing a broad-based Value Added Tax to the United States.

So, what should we make of a poll that says only 2% of self-identified "tea partiers" know the Obama administration cut taxes for most Americans in the current year? One obvious upshot is that they don’t know much about the content of the stimulus package. (Nor do most Americans, for that matter; only 12% of overall respondents said Obama cut taxes for most.)

But another take is that, as with most political issues, the public is operating in a low-information environment, and is reasonably processing the information it has. They see--accurately--that the Obama administration is expanding the government. That costs money, and will be paid for by taxpayers. As it happens, they won’t pay this year (unless they smoke or tan) but they will pay in the future.

While Tax Freedom Day falls on April 9 this year, the Tax Foundation also does an alternative calculation, reflecting where it would be if we paid enough taxes to cover government spending in the current year. Unsurprisingly, given the massive federal budget deficit, this date is much later: May 17, reflecting that government spending now consumes 38% of national income.

That’s the highest figure since World War II except for 2009. There will be slight moderation after the expiration of the stimulus package, but growing entitlement costs will immediately resume pushing the figure back up. That higher spending must eventually mean higher taxes.

In this environment, tax collections at 27% of national income (or even a more typical postwar level of 30%) will be unsustainable--we cannot run budget deficits of $500 billion and up every year. If Washington does not reverse its path on spending, more revenue will be needed--and the Tea Partiers will ultimately be proved correct about higher taxes.

This piece originally appeared in Forbes

This piece originally appeared in Forbes