Raising Taxes on the Rich Isn't the Ultimate Budget Answer

Fixing Washington's finances will take a lot more than President Obama has proposed so far.

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This March 20, 2012, file photo shows House Speaker John Boehner of Ohio and President Barack Obama walk down the steps of the Capitol in Washington.
Nearly a month after the election, Obama and the House Republicans are still trying to find common ground to avoid going over the cliff.

After a decisive electoral victory, President Barack Obama probably feels that his plan to raise taxes on the wealthy has been validated. He might want to reconsider that.

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Obama's plan is to leave taxes where they are for every household earning less than $250,000, while allowing tax rates for higher earners to revert to Clinton-era levels, before the George W. Bush tax cuts of 2001 and 2003 lowered them. The top federal tax rate would go from 35 percent to 39.6 percent, and the second-highest rate would rise from 33 percent to 36 percent. Obama would also raise taxes on investment income, which mostly accrues to the wealthy.

Democrats sometimes make it sound like this is all it would take to steer away from the "fiscal cliff"—the big set of tax hikes and spending cuts due to go into effect beginning next year—and eliminate the gaping deficits that have left Washington deeply in debt. But it wouldn't even come close.

At most, raising taxes on the wealthy would generate about $70 billion per year in additional government revenue, according to an Ernst & Young report prepared for several lobbying groups opposed to tax hikes. The deficit this year is likely to be about $900 billion, and the total national debt is more than $16 trillion. So higher taxes on the wealthy would only cut the deficit by about 8 percent. And over 10 years, they'd only reduce the total national debt by about 7 percent. (That $70 billion per year would increase gradually over a decade, due to inflation and economic growth.)

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Obama's basic argument is that you've got to start somewhere, and the wealthy should pay more before Washington even considers raising taxes on anybody else, or cutting spending in ways that would harm the needy or the middle class. Okay, maybe. But the problem with this approach is that it severely understates the depth of the problem, while perpetuating the fiction that Washington can get out of hock without inflicting any pain on the untouchable middle class.

The 2010 Simpson-Bowles report, which we're going to hear a lot more about in the coming weeks, laid out a more realistic plan for fixing the nation's finances. Here are a few of the recommendations: Raise the federal gasoline tax by 15 cents per gallon. Set caps on the amount of mortgage interest, healthcare benefits, childcare costs, charitable donations and retirement contributions that qualify for tax deductions. Kill most other tax credits. Raise the eligibility age for Medicare and Social Security, and reduce benefits for wealthier seniors. The plan would lower income tax rates and greatly simplify the tax code, but overall, the average taxpayer would fork over about $1,700 more each year to Uncle Sam. The tax burden would rise on every income group.

The Simpson-Bowles plan wouldn't even eliminate the national debt. It would simply cut it down to a manageable size and lower the risk of a crisis that jacks up U.S. borrowing costs, making the whole problem much worse.

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The point isn't that raising taxes on the wealthy is a bad idea. It's that way more will be needed to make a meaningful dent in the problem. Obama surely realizes this—he's the one who established the Simpson-Bowles commission, after Congress voted down the idea of establishing its own panel to recommend ways to fix the debt. But so far, Obama is basically telling the majority of Americans that the problem can be solved without affecting them at all. It can't.

It's all part of a political chess game, of course. Raising taxes on the wealthy is Obama's opening move. Republicans, led by House Speaker John Boehner, will counter with a demand to cut government spending and reform entitlement programs—especially Medicare—that are gobbling up a large and growing share of taxpayer dollars. It's still early in the game, but a compromise negotiated over the next couple of months might include cutbacks in tax deductions for the wealthy (rather than outright increases in their tax rates), coupled with modest spending cuts. That might be enough to avert the fiscal cliff for the time being.

But it still wouldn't make much of a dent in the overall national debt. The way to tell when Washington finally gets serious about that is to watch your own tax bill. The national debt won't go down until that starts to go up.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.