In a Monday op-ed in The Wall Street Journal (Paywall), President Biden urged Congress to help fight inflation by raising taxes on the very wealthy and using the money to reduce deficits. Does this strategy make sense in today’s economic environment?
At least in theory, tax increases could ease inflation. But not necessarily the reason for Biden’s suggestion. The tax hikes passed this year will not have a significant direct impact on government debt. But they can slow inflation by reducing consumer demand for goods and services.
Big warning
However, there are two major caveats. While Biden is focused on raising taxes on the wealthy and corporations to reduce deficits, the most immediate way to use taxes to curb inflation is to tax low- and middle-income households, whose spending habits are most sensitive to changes in the economy. income. The problem is that this puts the burden of fighting inflation on the most vulnerable. Moreover, the idea won’t get anywhere in the months leading up to congressional elections.
Then there is the question of time. Raising taxes could be a good policy today as the economy is still hot and inflation is still a major concern. But things could change soon. An inflation-fighting tax hike later this year or in 2023 may just be the wrong medicine — once a series of Fed rate hikes slow growth or even tip the economy into recession.
If Congress wants to use tax policy to dampen consumer demand, it must do so now. It needs to properly address these changes. Given that neither is likely to do so, and given that raising taxes today just to cut them again in a few months makes no sense, perhaps it should allow the Fed to fight inflation.
Who will deal with the tax increase?
To be fair, Biden’s WSJ acknowledges that “the Fed has primary responsibility for controlling inflation.” But on tax policy, he reiterated earlier calls for the IRS to provide more funds to collect unpaid taxes and undertake international tax reform. Then he said: “We should end the outrageous injustice in the tax code by allowing billionaires to pay lower rates than teachers or firefighters.”
Leaving the fight against inflation to politicians is always… embarrassing. While Democrats will staunchly resist efforts to raise taxes on low- and middle-income households, those are the people most willing to cut for every dollar of extra tax they pay. This is especially true because many of these households have been spending their savings after receiving government payments during the pandemic.
High-income households have been slower to respond to tax increases and may not cut spending sharply, although a drop in after-tax income would change their behavior somewhat. The impact today is likely to be particularly small because these consumers still hold large amounts of cash despite the recent stock market decline.
What about increasing corporate tax? Remember, today’s inflation is caused by a combination of high demand and unusually low supply of goods. It’s hard to imagine how increasing taxes on commodity producers would increase the supply of these products.
Bigger problems lie ahead
Biden is right that tax hikes could slow federal debt growth if the government doesn’t spend the new revenue. In its most recent forecast, the Congressional Budget Office estimated that the federal government will pay $8 trillion in interest over the next 10 years, driven by rising interest rates and growing debt. But the short-term fiscal impact of the tax hike is likely to be modest at best.
America may face more pressing problems than long-term debt. Treasury Secretary Janet Yellen has warned that the global economy could slip into recession due to a combination of factors including soaring and rising energy prices, tighter monetary policy, ongoing global supply chain problems and China’s COVID-19-related lockdowns. And the Russian invasion of Ukraine. These global circumstances extend far beyond the scope of U.S. tax policy.
Which brings us back to the political challenge. The Biden and Hill Democratic leadership is keen to piece together a congressional majority to raise taxes on the wealthy and businesses. But progress has been slow.
Few lawmakers on either side are willing to increase taxes on low- and middle-income households. Just ask Sen. Rick Scott (R-FL), who is proposing tax increases for households that currently pay no federal income tax. Elated Democrats wanted to turn his words into campaign ads. His ideas have been snubbed by fellow Senate Republicans.
All that’s left: Raising personal income taxes for working families might dampen inflation but exacerbate the plight of those already struggling. Biden is adamantly opposed to raising taxes on households earning $400,000 or less. Even if Congress can succeed, the timing could be completely wrong.
Perhaps the right answer is the usual one: With geopolitical and economic uncertainty peaking and Congress slow to respond, the hard work of tackling high inflation should be left to the Fed, not fiscal policy.
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