How would the economy be affected if the projected rise in primary spending under CBO’s alternative fiscal scenario (from about 18 percent of GDP in 2007 to about 35 percent in 2082) was financed entirely by a proportional across-the-board increase in individual and corporate income tax rates? Answering that question is difficult because the economic models that economists have developed so far would have to be pushed well outside the range for which they were initially developed. Any numerical estimate would be very speculative and heavily dependent on the model producing it.
Nonetheless, tax rates would have to be raised by substantial amounts to finance the level of spending projected for 2082 under CBO’s alternative fiscal scenario. With no economic feedbacks taken into account and under an assumption that raising marginal tax rates was the only mechanism used to balance the budget, tax rates would have to more than double. The tax rate for the lowest tax bracket would have to be increased from 10 percent to 25 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 63 percent; and the tax rate of the highest bracket would have to be raised from 35 percent to 88 percent. The top corporate income tax rate would also increase from 35 percent to 88 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion.
In my opinion, the fiscal outlook in the United States is worse than that anywhere else in the industrialized world. Other countries will be hit sooner and harder by demographic changes. However, looming much larger than demographics is the fact that health care spending is rising faster than the economy. In other countries, governments have clamped down on health care spending. To do that in this country would require a major revolution carried out in Washington, with hospitals, doctors, and many patients screaming in protest.
A simpler approach would be to convert Medicare from a blank check for reimbursing providers to a voucher system that allows seniors to purchase catastrophic health insurance. Vouchers would probably vary by income and by the person's medical condition. Apparently, Roger Feldman has a book explaining this concept.
My guess is that ultimately we will find our way to that sort of voucher system. But meanwhile, we'll try all sorts of futile alternatives.