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Raising Government Revenue: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- In arguably the greatest book ever written on public finance, The Theory of Public Finance, Richard Musgrave pointed out that there are three primary government functions: allocation, stabilization and income redistribution.

  • Allocation -- if market prices do not reflect all costs and benefits, government can step in to make appropriate adjustments, e.g., cigarette taxes;
  • Stabilization -- government should adjust its surplus/deficit to achieve full employment;
  • Income Redistribution -- if market forces generate a distribution of income that is not satisfactory to society, government should take corrective action.

But perhaps Musgrave's most important contribution was to point out that government policies designed for any one of these functions will affect the others. And that makes good government policy more of an art form than a scientific endeavor. Nevertheless, focusing on these three primary government functions is helpful, and I use them to examine possible roles for tax policy when the U.S. government moves from stimulus to austerity.

Allocation: Democrats vs. Republicans

The ideological divide between Democrats and Republicans is really an argument over allocation. The Republicans believe government should do less and have far less say over how the country's resources are allocated. The Democrats have an opposing view, believing there are many market imperfections that require more government involvement.

Stabilization

I have argued recently that although politicians are now focusing on austerity, it is yet not time for the U.S. to move from stimulus to austerity. My rule of thumb: Wait until the private sector has generated 200,000 new jobs monthly for at least four straight months. However, at some point the focus should switch from stimulus to a more neutral policy that will entail smaller government deficits. What are we looking for?

Congressman Paul Ryan's (R., Wis.) proposals, if accurate, would reduce the deficit from 9.72% to 1.6% of GDP over the next 12 years. Over the same period, Obama's deficit reduction proposals, if accurate, would reduce the deficit to 4.8% of GDP. Table 1 gives you a sense of the deficit reductions, if completed in 2011.

Ryan's proposals would reduce today's deficit by $1.2 trillion, while Obama's budget reductions would be $734 billion. With these figures in mind, I turn to possible revenue raising options.

Revenue Raising Options

1. End the Exclusion of Employer Contributions for Workers' Health Care

If your employer pays for your health insurance, he deducts the payment as cost from his tax base, and you get free health care. This treatment is unfair to the person who pays for his own insurance. From a distributional perspective, it hurts poor people more because they are less likely to have an employer who pays their health insurance. To rectify this, the company's health payment should be added to the recipient's income, and the recipient should be allowed to deduct this expense from their tax base. Stabilization Effect: This reform would generate $165 billion annually for the federal government.

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