U.S. federal deficits and the growth of federal debt make for attention-grabbing headlines and compelling soundbites. Investors often hear that we are “burdening our grandchildren” with exorbitant taxes in the future, and inferences are made that a return to higher marginal tax rates will ensure a return to “the good old days” when current government revenues could pay for all the government spending we cared to fund.
Rarely do the major media place fiscal policy in useful perspective; their claims often fail to withstand sound reasoning or empirical evidence. For example, it is true that to the extent we choose not to finance current spending with current taxation succeeding generations will be saddled with a higher tax bill; but it often goes unmentioned that current taxpayers are also free to invest on behalf of those future generations any money that is not taxed today. This is not an abstraction; as investment advisors we often encounter clients seeking to do exactly that.
To cut through the media clamor, it is important first to separate the question of how government spending should be financed (i.e., taxes versus borrowing) with considerations pertaining to the level and nature of spending itself. We can then focus on policy matters with serious consequences for economic growth and efficiency, particularly the composition and efficacy of government spending and the efficiency of various income tax rates and alternative tax structures. Recent research by AIER, our parent organization, goes to the heart of these questions. Below we reprint AIER’s recent summary of their observations.
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