Midlands Voices: Get serious about deficit spending

The writer holds the McGrath, North, Mullin and Kratz Endowed Chair in Business Law at the Creighton University School of Law.

As Federal Reserve Chairman Ben Bernanke recently reminded Congress, our government cannot continue on its current path of deficit spending. With the Congressional Budget Office projecting deficits of more than $1 trillion, a sound fiscal plan is needed soon, before it is too late.

The coming presidential election should be all about the outline for such a plan, but that has not been so. Voters should be asking why.

The Obama administration has failed to propose any serious spending cuts that would meaningfully address the magnitude of our deficits. Rhetoric lately seems focused on claims about the inequity of preferred tax rates for capital income earned by the "rich." Demanding that the "rich" pay their "fair share" may tap into the Schadenfreude of some voters, but it does not begin to provide a solution to our fiscal crisis.

Data for 2009, the most recent tax year available, show that qualified dividends and net capital gains (both taxed at preferred rates) totaled only about $400 billion. There are valid economic reasons for those preferential rates, which some might find mystifying. But a bigger and bolder point should not be lost — even confiscating all of this kind of income would not begin to solve our fiscal crisis.

While the popular imagination may be fueled by a belief that capitalists are making most of the income in this country, it is labor that generates the lion's share of reported income. Salaries and wages in 2009 totaled over $5.7 trillion, tenfold more than the reported income from interest, dividends and capital gains.

If taxes are going to be part of the answer to restoring fiscal stability, the golden goose is still the American worker. Voters who prefer raising taxes to cutting spending should consider that reality.

Just as high tax rates create disincentives for capital investment, high tax rates also create disincentives for labor that also affect our prospects for growth and employment. Our tax system penalizes achievement not only through graduated tax rates but also through hidden traps that penalize productive individuals.

Consider this example of a married couple — an administrator and a police officer — who together earn adjusted gross incomes (AGI) totaling $160,000. They have two children in college and incur more than $4,000 for each in tuition and related expenses, making them eligible for the American Opportunity Credit of $5,000 ($2,500 per student).

Suppose the police officer is offered additional part-time security work, for which she will receive $20,000. This job will require sacrifice and personal risk. Will the extra income be worth the effort?

The answer depends in part on the couple's marginal tax rate. Federal income tax rate schedules for 2011 suggest that a marginal tax rate of 28 percent (assuming taxable income over $139,350), state income taxes (estimated at 6 percent) combined with the employee's share of FICA taxes (7.65 percent) will push their marginal rate to 41.65 percent — already steep by most standards.

But this couple's true marginal rate is actually 25 percent higher because the American Opportunity Credit phases out between AGI of $160,000 to $180,000, raising their tax bill by $5,000. The family keeps only $6,665 while their government "partner" reaps $13,335 from this extra effort.

Staying home and doing with less starts to look pretty good at this point.

Adverse consequences extend throughout the economy, not just for this family. Without the extra income, the family may do their own cooking instead of patronizing local restaurants, and do other things for themselves, such as cleaning or remodeling their home rather than paying contractors.

Those activities save money for the family, but they also cost the Treasury due to the lost income that would have been generated by goods and services provided by others. It does not take much creativity to see that average folks are harmed by the wrong incentives.

The human drive to be productive does not function when government takes too much. Voters need to get beyond the political rhetoric and consider the reality of our government finances.

We cannot tax our way to fiscal health. We will need to spend significantly less — with real cuts, not just decreases in the rate of growth — to match our revenue base. Tax reform is needed, but those reforms will need to be designed with incentives for labor and capital in mind.

After all, those who will be taxed will provide the future growth we so desperately need.

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