The closer the U.S. economy gets to the "fiscal cliff" the more panicked the spending interests appear to be. That's because they know that House Speaker John Boehner and his allies in Congress are standing firm against an increase in income tax rates—which the spenders need only for political reasons—even while being open to increasing revenues to the federal government.
This is an important distinction that doesn't get enough attention, in part because it is counter-intuitive. Higher rates—especially where marginal income tax rates are concerned—often produce lower revenues as economist Art Laffer demonstrated with his eponymous curve. Conversely there are some tax rates that can be cut, the capital gains tax rate springs to mind, where lower rates produce higher revenues—at least in the short term—because they promote increased, taxable economic activity.
In any event, the spending interests have it in mind to increase federal spending permanently as a percentage of U.S. gross domestic product, historically between 18 and 19 percent in the postwar period. The White House doesn't have a plan but, for those who do, they anticipate spending will ratchet up to something between one fifth and one quarter of GDP—which is a huge, even historic increase.
The kind of revenue such an increase would require cannot be achieved by raising taxes on "the wealthiest Americans," as President Barack Obama likes to say. It demands a new tax, one imposed on the entire U.S. economy, like a carbon tax.
As William Gale, of the leftwing Tax Policy Center—a joint project of the Brookings Institution and the Urban Institute—said recently at a forum sponsored by the centrist American Enterprise Institute, "Higher taxes can and should be part of the long-term fiscal solution." The fiscal outlook, he said, makes that a certainty. The carbon tax, he added, is therefore a good idea—since it accomplishes two goals: economic and environmental. Meaning it raises money and addresses the problems posed by global climate change since it will have an impact on the production of so-called greenhouse gases.
A carbon tax is neat, clean, and largely transparent, making it attractive even to some on the right who are engaged in the search for a unicorn—meaning the magic formula for raising federal revenues through higher tax rates or new taxes that does not damage the U.S. economy. The fallacy of this approach, of course, is that there is no way to shift 5 percent of U.S. economic activity from the private to the public sector without seeing an adverse impact on job creation and economic growth.
Moreover, as even its proponents allow, a carbon tax alone would not raise enough money and, in order to compensate for its regressivity, would require—as a political matter—the creation of a new entitlement program designed to rebate its cost to low income households. Some self-described environmentalists like it because of its environmental benefits but, again, they would not be as significant as some sort of overall cap on greenhouse gas production. Meaning the carbon tax is, from their perspective, merely a weigh station on the road to a more restrictive environmental regime—which will do even more damage to the U.S. economy.
Nonetheless the idea is finding support in surprising quarters, including at the aforementioned American Enterprise Institute which seems to be leading the charge for a carbon tax on the right. Unfortunately they are looking at it in isolation rather than trying to see its impact on the larger economy—the down sides, which are real, as well as the up sides, which are not really all that positive. Higher or new taxes to feed the special interests' appetite for spending are not the way to avoid the fiscal cliff. America will only find its way out of the current mess if Congress and the president pursue policies designed to generate real growth in the economy. They won't be enough to completely close the gap between spending and receipts and it won't permanently fix the problems posed by long-term entitlements like Medicare, Medicaid, and Social Security but they will create enough room to maneuver to come up with real solutions that can win the support of the American people. A carbon tax, on the other hand, is just one more unnecessary burden on U.S. productivity.