Higher Taxes = Deficit Reduction? Maybe in a Static Economy

Karen Campbell / September 21, 2010

A Washington Post article today reports that letting the Bush tax cuts expire would nearly close the fiscal gap. This static logic misses two key dynamic aspects of the economy: (1) the political incentives that higher taxes bring about, and (2) the economic incentives of such policy.

1. Political Incentives. With higher revenues initially coming in from higher taxes, there would be a stronger political incentive to increase spending. That is, taxpayers have no guarantee that their higher tax payments would actually go to deficit reduction. If history is any lesson, it is more than likely that Congress would lever up on the higher tax revenues, expanding the government even more with borrowed funds. The net result: Deficits would remain, but now there would be an even higher level of overall debt. (more…)