Why Tax Increases Are Inevitable

If you haven’t heard of Club Wagner, you may start hearing more about it in the coming months. While not a reference to a night club, the actor who portrayed Dr. Evil’s Number 2, the former mayor of New York City, his senator father, or the two schools named after him, Club Wagner is an unofficial collection of public policy thinkers who dare to advocate what everyone knows, but few publicly acknowledge: tax increases are inevitable.

Created by David Leonhardt on the New York Times Economix Blog back in July, this assortment of thinkers is named after the 19th-century German economist Adolf Wagner, who predicted that taxes would rise as societies became wealthier. Economix’s bi-partisan list Club Wagner members include John D. Podesta, former White House Chief of Staff under President Clinton, former Director of the Obama transition, the head of the Center for American Progress; Treasury Secretary Timothy F. Geithner; former Fed Chairman Alan Greenspan; Peter Orszag, the Director of the OMB; New York Times conservative columnist David Brooks; and Bruce Bartlett, the former domestic policy advisor to President Reagan.

So, why should public sector practitioners care about this? Because the next phase of the economic recovery is going to impact public sector financing and government deficits. For example, a December 22nd Washington Post article reports that many states will begin to exhaust their funding for their unemployment benefit programs in 2010. According to the projection,

“…[T]he budget gaps are expected to spread and become more acute in the coming year, compelling legislators in many states to reconsider their operations. Currently, 25 states have run out of unemployment money and have borrowed $24 billion from the federal government to cover the gaps. By 2011, according to Department of Labor estimates, 40 state funds will have been emptied by the jobless tsunami.”

The situation is reinforced by a recent study by the National Association of State Workforce Agencies that found that the number of people applying for benefits has increased (no big surprise in this economy), while the payroll tax rate supporting those benefits is at historically low levels. So, in an effort to encourage and support businesses in their state, legislators cut the payroll taxes, exposing the program administrators to risk if there should be an increase in the number of unemployed. With the economic downturn, they find their unemployment benefits substantially underfunded.

Everyone who balances a checkbook knows that you need to have more income than expenses, and when you don’t, you need to find more revenue from another source. For these benefits, which are separated from each state’s general fund, there are two options: cut benefits or raise taxes. However, while the policy makers in each state choose which challenge to address, providing benefits or creating jobs, the program administrators have been boxed into a corner. The news of the increase in underfunded programs is likely to spark a debate among policy-makers about whether to cut benefits or borrow more to cover a temporary increase in demand.

Where do these difficult choices lead us? Unless each state makes the hard decisions about their long-term fiscal strategy that are necessary today, we could end up with what David Ignatius calls the “Californization of America”, where the opposing forces of spending big and taxing small result in federal bailouts to the states. In today’s economy, there is a general paralysis in taking any action that is seen as having a negative impact on business. However, with bipartisan support for increasing taxes growing with Club Wagner, public officials need to look at tax increases as a common sense solution to budgetary shortfalls.