The Federal Government's Increasing Tax Impact On the Private Sector

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America's private sector tax burden will hit a record high next year and continue to grow. Although recently held artificially low by the weak economy, this year's federal tax hike and continued high spending, combined with state and local taxing and spending, is poised to put an unprecedented squeeze on the private sector in 2014. Only by understanding how these factors combine - rather than viewing them in isolation, as is so often done - can we understand the threat they pose to our long-term competitiveness.

The basic variables composing total government tax and spending are routinely seen as separate events, thereby undercounting their important economic impact. For example, the weak economy has held federal revenues to their lowest level relative to GDP since the 1950s. Yet federal taxes are just part of the total tax equation.

While certainly consequential, assuming that the 11.3% of GDP that state and local spending comprised was offset by revenues (as is the case in almost every state, because of balanced budget requirements and much less ability to borrow than Washington's), federal revenues accounted for just 58% of America's total tax burden in 2012 - 15.8% of GDP as compared to state and local's 11.3%. In that context, America's 2012 tax burden was roughly equal to 2004's.

It is also important to not only understand from whence this total tax burden arises, but where it falls: the private sector. The private sector is America's productive engine. Like Atlas it must support the total tax burden, while still producing the economic growth needed to sustain and (hopefully) increase our standard of living.

Yet Atlas must stand on something, and that something - the portion of the economy available for its use - is eroding. Therefore when looking for government's total economic impact, this does not simply mean taxes, but government spending, which diverts resources from the private sector. We can give a rough approximation of the private sector's share of GDP by subtracting government's spending
from the total economy.

In 2012, federal government spending equaled 22.7% of GDP. When combined with state and local government spending of 11.3% of GDP, total government spending amounted to 34% of GDP - just over one third of the economy - thereby leaving the private sector slightly less than two-thirds of America's economy to utlize to pay a total tax bill of well over a quarter of America's economy.

America's private sector finds itself facing a Scylla and Charybdis situation. Government does not just take product from it, but diverts resources from its use as well. Essentially, America's private sector is being asked to pay more with less.

Thus the appropriate way to view the total government impact on the economy is the total tax impact on the private sector. In 2012, this ratio of total taxes to the private sector equaled 27.1% of GDP to 64% of GDP. - a ratio of 41.1%. Put in its proper context, 2012's total government impact on the economy matched that of 2003 and 2004.

High as this full government impact on the economy is, it will soon jump substantially. Because of 2012's tax increases and a stronger economy, the Congressional Budget Office estimates that federal revenues will increase to 17.5% of GDP. Assuming that state and local spending and revenues remain at 11.3% of GDP, and taking CBO's estimate that federal spending drops to 21.7% of GDP, 2013's total government to private sector ratio rises to 43.1%.

To put this level into context, America did not cross that threshold until 1991, and hit it just 4 times over the next 14 years.

However, 2014's rato is projected (again using CBO estimates and the assumption that state and local government tax and spending stays at 11.3% of GDP) to hit 44.1% - a record since 1948, when the Office of Management and Budget started including state and local spending totals - and 2015's to reach 45.2%.

Over the next 10 years, the ratio will never fall below 44% and will be above 45% in 5 of those years, with 2023 hitting 46%. All this is based on CBO's assumption that federal taxes and spending do not increase and the admittedly optimistic assumption that state and local spending stays at 11.3% for the entire decade.

These numbers are not to be taken lightly. The federal tax burden cannot be taken in isolation because it affects the economy in combination - along with federal spending, and state and local taxing and spending - having a total fiscal impact far greater than the individual elements alone.

That total fiscal impact is important to global investors seeking the highest returns on their mobile capital. Joining an increasingly squeezed American private sector is likely to look decresingly attractive.

Far from having a low tax burden - just because federal revenues as a share of GDP have fallen with a weak economy - America is just a year away from hitting its highest total tax level ever on the private sector. The question that remains is: Are we about to hit our lowest level of global competitiveness as well?

J.T. Young served in the Treasury Department and the Office of Management and Budget from 2001 to 2004, and as a congressional staff member from 1987 to 2000. 

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