An interesting exchange took place during Federal Reserve Board chairman’s Ben Bernanke’s appearance before the Senate Budget Committee today. A Republican backbencher, Senators Ron Johnson of Wisconsin, asked whether the government can “extract more than 18.1 percent of GDP” in taxes without damaging the economy.
It wasn’t an arbitrary choice of benchmarks. That’s about the average level of federal taxes collected over the last three decades, and about where taxes would remain if the Congressional Budget Office’s “alternative” budget scenario – one that assumes all the Bush-era tax cuts stay in place – remains in effect over the next decade. This year’s estimated 16 percent is due to the payroll tax cut and the still high level of unemployment.
“That’s what you’re elected to do,” Bernanke replied, “to figure out the right role of government in the economy. It’s true that beyond a certain point, higher taxes imposes costs on the economy.”
But with spending on Medicare and Social Security rising because of the retiring Baby Boomers, spending is likely to soar to 24 or 25 percent of GDP, Johnson claimed. Wouldn’t the level of spending needed to cover those costs undermine the economy?
Unlike his predecessor, Bernanke is nothing if not straightforward, even when he refuses to answer a question. “At some point, Congress is going to have to make a trade off,” he said. “If you want a low-tax economy, you’ve got to make the tough decisions on the spending side. On the other hand, if you want to spend more, you have to figure out how to raise taxes.”
Here’s the problem with that answer. He didn’t challenge the accuracy of Johnson’s numbers.
The demographic realities of the aging Baby Boom are daunting, but not overwhelming. Last year, according to the Medicare trustees report, there were about 49 million people eligible for Medicare, a shade over the number on Social Security (whose full retirement age is in the process of moving from 65 to 67). That’s about 15.7 percent of the 311 million Americans.
But in 2020, seniors will make up 19.1 percent of the nation’s projected 334-million population on its way to reaching 22.5 percent 358 million people in 2030. That’s an increase of nearly seven percentage points in the share of the population that will be elderly.
How much will it cost to provide Medicare and Social Security for this larger population? Last week, the Congressional Budget Office offered its spending projections for the rest of this decade. Social Security, which consumed 4.8 percent of GDP in 2011, is projected to rise to 5.3 percent of GDP in 2020 on its way to more than 6 percent in 2030. Medicare, which consumed 3.7 percent of economic output in 2011, will rise to 3.9 percent in 2020 on its way to about 5 percent in 2030.
In other words, these largely taxpayer-supported programs for the nation’s elderly will consume 11 percent of economic output in 2030, up from 8.5 percent today.
By simple arithmetic, the tax take average of the past several decades wouldn’t have to go from 18.1 percent to 24 or 25 percent to take care of aging boomers. It would have to go to about 21 percent.
While that could slow economic growth somewhat, it would hardly be an Armageddon for the economy. For instance, under CBO’s baseline scenario, which assumes expiration of the Bush-era tax cuts in 2013 and another $1.3 trillion in discretionary spending cuts over the next decade with half coming out of the military, the government’s total tax take would rise to – drum roll please – 21 percent of GDP.
There are many reasons why going back to the tax rates the nation had prior to 2001 isn’t the best answer to the nation’s debt problems. The tax code is badly in need of reform on both its personal and corporate side.
But the nation hasn’t had an informed discussion yet about what the ultimate take ought to be from that reformed code. The correct answer is not a fixed point like 18.1 percent, but what level of taxation the broader population will support to provide retirement and health care security for an aging population.
