The 2% Solution-- A cure for what ails America?

Arthur Conan Doyle's Sherlock Holmes would create a solution of 7% cocaine and 93% water for his drug habit. When America's economy ails, the drug of choice for American politicians appears to be taxes.
As reported yesterday in The New York Times,

President Obama will propose further tax increases on the affluent to help pay for his promise to make health care more accessible and affordable, calling for stricter limits on the benefits of itemized deductions taken by the wealthiest households.

Today, February 26, 2009, the Wall Street Journal weighs in on the matter discussing The 2% Illusion,

President Obama has laid out the most ambitious and expensive domestic agenda since LBJ, and now all he has to do is figure out how to pay for it. On Tuesday, he left the impression that we need merely end "tax breaks for the wealthiest 2% of Americans," and he promised that households earning less than $250,000 won't see their taxes increased by "one single dime."

This is going to be some trick. Even the most basic inspection of the IRS income tax statistics shows that raising taxes on the salaries, dividends and capital gains of those making more than $250,000 can't possibly raise enough revenue to fund Mr. Obama's new spending ambitions.

The Journal then proceeds to show the weakness of the assumption that the tax increase will be a cure-all remedy. For instance,

The proposal is to raise the highest rate "only to 39.6%, plus another two percentage points in hidden deduction phase-outs. He'd also raise capital gains and dividend rates, but those both yield far less revenue than the income tax. These combined increases won't come close to raising the hundreds of billions of dollars in revenue that Mr. Obama is going to need."

But let's not stop at a 42% top rate; as a thought experiment, let's go all the way. A tax policy that confiscated 100% of the taxable income of everyone in America earning over $500,000 in 2006 would only have given Congress an extra $1.3 trillion in revenue. That's less than half the 2006 federal budget of $2.7 trillion and looks tiny compared to the more than $4 trillion Congress will spend in fiscal 2010. Even taking every taxable "dime" of everyone earning more than $75,000 in 2006 would have barely yielded enough to cover that $4 trillion.

The bottom line is that Mr. Obama is selling the country on a 2% illusion. Unwinding the U.S. commitment in Iraq and allowing the Bush tax cuts to expire can't possibly pay for his agenda. Taxes on the not-so-rich will need to rise as well.

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