02/05/2015 04:40 pm ET Updated Apr 07, 2015

The Mismatch of Obama's Middle-Class Economics

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With his recent budget proposal, President Obama has provided some badly needed details for the bold and ambitious set of social programs and tax hikes that he has dubbed "middle-class economics." Many parts of the proposed budget are unlikely to advance in a Republican Congress.

But President Obama's vision for a new era of "middle-class economics" suffers from a larger defect: there's a fundamental mismatch between the President's spending programs and his tax proposals. Even with the astronomic growth of the top 1 percent, and the widening chasm between the "haves" and "have nots," raising taxes only on the wealthy won't generate enough revenue to provide the type of serious public investments and social spending required to usher in a period of "middle-class economics." In short, simply soaking the rich won't help us reduce inequality or combat poverty.

The proposed budget concedes this fact. The nearly $4 trillion in planned spending for the next fiscal year overshadows the roughly $3.5 trillion in projected revenue. And in the long term, the president's budget does little to address the impending explosive growth in entitlement spending, namely Social Security and Medicare.

Like liberal Democrats before him, President Obama seems obsessed with making sure the rich pay "their fair share." While such populist rhetoric may play in Peoria, it doesn't pay the bills. Nor does it do much to address stagnant wages for the lower and middle-class. That's because tax hikes on the wealthy focus only on the revenue side of the broader tax-and-transfer system.

Historically, progressive lawmakers could get away with focusing only on the revenue-raising side of fiscal policy. Indeed, a hundred years ago when our modern income tax first took shape, it made sense to concentrate on progressive taxation.

Back then, tax experts and leading politicians were reacting to a highly regressive system of indirect taxes in the form of the tariff and national excise taxes on alcohol and tobacco. The natural response was to enact graduated taxes on income, wealth-transfers, and business profits. These levies helped recalibrate the tax burden across socio-economic classes and geographical regions.

American taxation became even more progressive during the two world wars, when Congress and liberal presidents assiduously turned to the tax system to underwrite the war efforts. As a result, the United States developed one of the most progressive tax systems in the world. High-end graduated taxes based on the notion of "ability to pay" became the touchstone of American tax policy.

But one of the unintended consequences of this historical process was the neglect of the spending side of the tax-and-transfer system. By neglecting the modern state's potentially tremendous spending powers, an early generation of leaders created a type of fiscal myopia that has continued to afflict American policy making.

In some ways, President Obama seems to have inoculated himself from this historical myopia. His budget proposals call for an array of modest social spending programs on infrastructure, education, and childcare.

But the link between these social-welfare provisions and tax hikes on the rich is tenuous at best. And at worst, focusing only on soaking the rich leaves untouched the problem of increasing inequality and the looming crisis in entitlement spending.

President Obama has previously described our growing inequality as "the defining challenge of our time." But if he is serious about taking on this challenge, he must go further in removing the historical blinders of American fiscal myopia. He must look globally to see how other advanced industrial nations have combated inequality.

They have done so not by focusing exclusively on progressive taxation. Rather, countries like Germany, the Netherlands, and Sweden have used broad-based regressive taxes on consumption, like the value-added tax, to generate robust public revenues that in turn can be used to fund a variety of egalitarian social-welfare programs from investments in human capital to national health care to high quality childcare.

Some commentators on the U.S. political left have welcomed Obama's call for a new "middle-class economics." They see it as an opening salvo for a rejuvenated Democratic Party committed to big and benevolent government. But there's nothing big or noble about a government that can't generate the revenue to follow through on its promises.


Ajay K. Mehrotra, a professor of law and history at Indiana University Maurer School of Law - Bloomington, is the author of Making the Modern American Fiscal State.