How the Taxation of Labor and Transfer Payments Affect Growth and Employment

by Simon Johnson, Peterson Institute for International Economics

May 16, 2012

The United States faces a serious medium-term budget deficit problem—realistic forecasts show a rising trajectory for US government debt over the next two decades. The primary drivers of the large increase in public debt over the past decade were the George W. Bush–era tax cuts, wars in Iraq and Afghanistan, Medicare Part D, and the financial crisis that began in the fall of 2008. This is the sixth surge in national debt in US history; the previous five surges were all caused by war. The current nature of the US financial sector generates system risk that has negative macroeconomic implications in the United States, including for its public finances. Looking forward, as society ages the United States faces increasing pressures on social security, Medicare, and other forms of basic social insurance. Healthcare spending—not just the government paid part of health care—needs to be brought under control. In this context and over the coming decades, the United States needs to make a longer-term fiscal adjustment. Part of that should include additional tax revenues, phased in over the next two decades. Raising taxes is never easy or pleasant, but not extending the Bush-era tax cuts is the best way to strengthen revenue and sustainably fund the federal government.

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