The Debt Gray Rhino Continued: Can We Tax Our Way Out?
What about reducing the US national debt by increasing tax revenue?
We’ve looked at the gap between the policy menu on offer and policies that could boost annual GDP growth to 3 percent or more.
There are many policy options that could increase tax revenue and provide other economic benefits (or economic harms) at the same time.
Tariffs
Higher tax rates: on higher incomes
Higher capital gains tax rates
Closing loopholes and exemptions.
While the purpose of this post is to point out ways to increase tax revenue, not all taxes are the same. I have focused on areas where tax policy could be improved along with reducing the deficit. My philosophy on taxes is that when you want less of something taxing it is a good option, but when you want more of something, tax less or even subsidize it. (And, by extension, don’t subsidize things that don’t need a boost.)
But first, a word on tax cuts. We left these out of last week’s growth policy analysis because the tax cuts passed this summer and in 2017 are not quite the growth boosts that some make them out to be.
About those Tax Cuts
As structured in the July budget package, the administration’s tax policy will do precious little if anything to increase growth; in fact, it’s more likely to do the opposite. Study after study has debunked the claim that tax cuts pay for themselves –particularly when the lion’s share of the benefit goes to the wealthiest Americans.
The Center on Budget and Policy Priorities and others have demonstrated that the original 2017 Tax Cuts and [sic] Jobs Act increased federal debt and failed to deliver the promised YUGE growth and jobs in the following two years. (Naturally, the Covid-19 pandemic made it harder to extend the analysis beyond the end of 2019.) Comparing the fourth quarters during the period 2017-19 to 2015-17, GDP growth barely moved, from 2.6 percent to 2.7 percent. Consumer spending growth slowed from 2.8 percent to 2.4 percent. And growth in business investment –the area that one might have expected to benefit most from tax cuts on the wealthy, according to the tired old logic-- slowed from 4.5% to just 3.1 percent.
As another study, by Owen Zidar of the Chicago Booth School of Business, pointed out, “The positive relationship between tax cuts and employment growth is largely driven by tax cuts for lower-income groups, and that the effect of tax cuts for the top 10% on employment growth is small.
But the tax cuts passed this July did the opposite, focusing the benefits on the highest earning groups.
As Jack Landry, lead researcher at the Jain Family Institute, puts it: “Deductions aimed at middle and working class households are so minor that their fiscal cost is less than five percent of all tax cuts in the law. The lowest-income 60 percent of Americans will get an average tax break of just $100. Even considering all new tax breaks in OBBB (beyond the new deductions but excluding extensions of expiring provisions), the average benefit for the lowest-income 60 percent of Americans increases only slightly, to $140.”
The Tax Policy Center estimates that 60 percent of the tax cuts passed this July will go to the top 20 percent of earners. “Those making less than $20,000 would pay $40 more in taxes after losing their premium tax subsidies,” Urban Institute senior fellow Howard Gleckman wrote based on the May version of the bill. “Middle-income households would receive an average tax cut of about $1,800, or about 2.4 percent of their after-tax income.”
Tax cuts for lower and middle earners will be eclipsed by price increases expected from new tariffs, which The Budget Lab at Yale estimates will cost the average American household $2,400 a year – way more than that $140 average tax break and still far above what middle-income taxpayers may get in tax savings .
About that Tariff Revenue…
Okay, so what about those tariffs? The administration has been trumpeting how much the new taxes on imported goods are bringing in.
The Bipartisan Policy Center reports that through August 21, the US has raised $135 billion in tariffs and other excise taxes, a bit more than twice the level in the same period of 2024. (These are gross figures, which tend to run between 80 percent and 90 percent of net revenue. Deducting tariff refunds and “other excise tax revenue, net figures won’t be available until the next Monthly Treasury Statement.)
S&P Global Ratings cited increased tariff revenue expectations when it affirmed its “AA+” U.S sovereign credit rating on August 19.
Some estimates put 2025 tariff revenue at $300 billion or more. Given that so many companies and consumers increased their overseas purchases earlier this year to beat the tariffs, I would be surprised if that volume of imports continues. Even if tariff revenue doubles from 2024, that would put it at just over $150 billion net (or just under $200 billion gross). In other words: still a drop in the bucket compared to the deficit as a whole — and even to revenue lost to tax cuts for the wealthiest Americans.
To be sure, tariff revenue has risen as a percentage of all federal government revenue, but from a low base —going from just under 2 percent in April to just over 3 percent in August.
Since at least part of the point of those tariffs is to shift consumers’ preferences to domestic goods and reduce imports, I wouldn’t put my money on those tariff revenues growing as much as the administration claims.
Other Tax Revenue
Okay, so what about increasing revenue through other tax streams?
In July I shared several modeling tools for reducing the national debt. The base data for many of them was the Congressional Budget Office’s Options for Reducing the Deficit: 2025 to 2034. If you have not yet played around with them, do so now. There are many credible ways to reduce the deficit, both by increasing revenues and cutting spending
Let’s go back to some of the options these models analyze for their potential to increase revenues. Some of these will be familiar, but I’ve added a few new twists that have not gotten a lot of attention but should.
Reduce Itemized Deductions. This could happen in many kinds of ways: an absolute numerical cap or a percentage of income; a focus on specific types of deductions; or reduction or complete elimination of all deductions. A 2022 CBO analysis estimated that various options could reduce the deficit by between $500 billion and $2.5 trillion over a decade. My preference would be to rewrite the tax code in a way that would preserve medical deductions along with state and local tax deductions for everyone but the wealthiest, and minimize damage to genuine charitable giving (as opposed to, say, think tanks whose work is highly partisan).
Mortgage interest deductions are a category unto themselves. The Budget Lab at Yale has proposed several reforms to this policy. As they note: “Most of the deduction’s value accrues to higher-income households who can afford to buy a home independent of tax policy, and evidence suggests it does little to promote homeownership in the aggregate.”
Increase Individual Income Tax Rates on High-Income Households. Undo the 2017 tax cuts that Congress allowed to be extended this year and raise the top income bracket. The Penn Wharton budget model (generated in late 2024) calculates that increasing the top marginal rate to 45 percent starting in 2025, which could generate close to $834 billion over the coming decade and $3.9 trillion through 2054.
This is still far below historical highs of as much as 92 percent in 1952, according to the Tax Policy Center. Feel free to do your own math on how much of a dent even a few more percentage points would put in the deficit. Remember, the lower the deficit, the lower interest rates can go, creating a virtuous circle of economic growth, lower tax burden, and more capital available for those very same top earners to invest in the real economy.
Create a Value-Added Tax for High-Value Goods. This is essentially a sales tax on the increased value at each step of production and sales. To be sure, many Americans would find this to be complicated and grumble at a “new” tax even though it’s not really new. Introduced by France in 1954, the VAT is now used in 175 countries around the world. The Peter G. Peterson Foundation estimates that a 5 percent VAT could raise between $2.2 trillion and $3.4 trillion over a decade. Consumption taxes can be regressive, so to avoid that unintended consequence, I’d propose only imposing this on higher-value and luxury goods.
Reduce Estate Tax Exemptions. Though less than 1 percent of federal tax revenue comes from estate taxes, this change would send an important political signal considering rising public resentment of the ultra wealthy. Also, dead people cannot complain (though no doubt they will be noisy while still alive). A higher estate tax will encourage people to pass their assets along to later generations sooner –potentially contributing to economic growth (or spoiled adult children, but that’s another issue). Two options are lowering the estate tax exemption and taxing unrealized gains at death.
Add a Carbon Tax -Especially for AI/Data Centers. The US electricity grid is in a sad state, especially with the added burden of new data centers and use of energy- and water-intensive Generative AI. The Peter G. Peterson Foundation and others suggest that a carbon tax of $25 per ton could raise $1 trillion in revenue over a decade. Because of this tax’s potential regressive effects, it could be accompanied by a credit for the lower [insert your preferred percentage number percent.
Raise Social Security and Medicare Ages for White Collar Occupations. I know, I know: third rail of politics. But the White House already has gone so far beyond norms that nothing is off the table. Raising the full-benefit age from 67 to 70 could raise $1.6 trillion through 2064, according to Penn Wharton estimates. But not all jobs are as physically taxing as others, so the retirement age should reflect that. People working in blue-collar occupations —many of which are hard on the body and thus become more difficult as people age, and which pay less than most white-collar jobs— should be allowed to get full benefits at earlier ages.
Reform Capital Gains Taxes. Various proposals are floating around for raising taxes on capital gains —from increasing rates on capital gains and qualified dividends to taxing unrealized gains (as above).
I would introduce two important additions: first, separate secondary market capital gains from gains on housing and on investors who provided fresh equity capital. Capital gains in the stock market are not the same as the hard work of entrepreneurs, nor of gains on homes which for many families are their primary asset.
Then I’d tax secondary capital gains at ordinary tax rates, one of the possibilities raised in the Penn Wharton Budget Model. Not only could this generate $1.8 trillion by 2054, this would have the benefit of redirecting capital to direct real-economy investments instead of speculative paper gains. Yes, the narrative is that high stock markets encourage investment in early-stage companies with the hope of lucrative exits. But why not encourage a more direct route to real-economy gains?
I’d also revise the meaning of “Long term.” A one-year investment does not fit the bill -though to be sure, it is long-term when compared to lightning-fast algorithmic trades.
Corporate Tax Rates. The Biden administration’s move toward a global corporate minimum tax was positive because it reduces incentives to game the tax system by shifting domicile. For the record, I also think that lowering the U.S. federal corporate tax rate in recent years was the right thing to do to attract foreign direct investment and keep U.S. investment here.
Reduce and replace outright subsidies with blended finance and risk sharing —and yes, at times with equity stakes. President Trump has opened the Pandora’s box of government stakes in companies with his Intel stake. This opens the way to an approach that the economist Marina Mazzucatto has proposed: let taxpayers benefit from gains from successes in which they have provided capital —in other words, socialize successes, not just bailouts.
As you can see, there are many, many options to explore to raise revenue to reduce the deficit. Let’s get a public debate going on these now.
Next up: What Spending Cuts Make Sense?