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OPINION We Can't Tax Our Way Out of the Entitlement Crisis By R. GLENN HUBBARD
August 21, 2008

Given the hearty support Democratic presidential candidate Barack Obama received in Europe last month, he must have noticed the surprise and skepticism among some Germans when he asked that Europeans contribute more for defense. Many Europeans argue they cannot afford such an additional expenditure.

They are right. And therein lies a cautionary tale for the United States, because continental Europe has been following something like Mr. Obama's plans for spending and taxes.

Mr. Obama has revealed his plans in stages. First, on his campaign Web site, he indicated he would solve the long-run solvency of Social Security (a good thing). In a Sept. 21, 2007, op-ed in Iowa's Quad-City Times, he ruled out benefit cuts to achieve solvency and looked first to payroll taxes (a bad thing). Last week, on this page, his economic advisers clarified his evolving tax proposals.

The spending shortfalls in Social Security and Medicare are large. According to the Congressional Budget Office, Social Security and Medicare spending left unchecked would, after a generation, consume about 10 percentage points more of GDP than it does today.

Simple arithmetic suggests that with this much more of GDP eaten up by the two programs, all federal taxes on average would have to be raised by more than 50% to make up the shortfall. Research by economists Eric Engen of the Federal Reserve Board and Jonathan Skinner of Dartmouth suggests that such a tax increase would reduce long-term GDP growth by about a full percentage point. This is no small matter: Think of it as reversing all of the gains in our long-term growth rate from the productivity boom of the past 15 years.

Now it is easy to understand European concerns about higher defense spending. Large entitlement budgets almost certainly cannot be financed with growth-chilling taxes alone. Spending on other areas, including defense but also education, research, etc., must also be adversely affected.

In their op-ed on this page, Obama economic advisers Jason Furman and Austan Goolsbee noted that taxpayers whose incomes exceeded $250,000 would face an additional Social Security payroll tax increase of four percentage points (in addition to a five-percentage-point increase in the top marginal income tax rate). This new payroll tax plan would affect the top 3% of earners.

The new payroll tax hike is more modest than the one Mr. Obama hinted at last fall, which might have uncapped the payroll tax entirely. But it would also do very little to shore up Social Security, since it means that no more than 15% of Social Security's long-term funding gap would be closed. Thus, if Mr. Obama is indeed opposed to reductions in Social Security spending growth, he is necessarily committed to large future payroll-tax or general income-tax increases.

And what of those other tax increases? In May 2007, candidate Obama proposed to offset costs of his health-care plan in part by allowing the Bush tax cuts on Americans earning over $250,000 to expire. But Mr. Furman and Mr. Goolsbee suggested that dividend and capital gains tax rates would be raised to 20%, but well below levels (for dividends) prior to the 2003 tax cut. While kudos are due to this tempering of a tax increase, one can infer from the candidate's earlier statements that the senator had counted on these revenues to offset health-care spending and to pay for middle-class tax cuts.

In short, Mr. Obama has articulated a plan for higher federal spending, leaving open the question of what tax increases are next.

If Mr. Obama is going to increase spending, will he raise the money by higher business taxes instead? He has already distanced himself from John McCain's call to reduce America's corporate tax rate, and he is committed to raising tax rates on successful small business owners who pay individual as opposed to corporate income taxes. Does this mean he will raise tax burdens on individuals with annual incomes less than $250,000?

In a June 26 interview on the Fox Business channel, Mr. Obama said he wanted to roll back the Bush tax cuts for those in the top 5% of incomes -- that is, about $145,000 per year. He also voted for the Democrats' fiscal year 2009 Budget Resolution, which would raise taxes on individuals earning $42,000 or more.

There is another fiscal way. Balancing the federal budget without a tax increase is possible, but will require strong fiscal restraint. To achieve full-employment budget balance by the end of the next president's term in office, federal nondefense spending growth needs to be restrained to 2% per year instead of the currently projected 4.5%. And modest defense spending increases to fund costs of needed improvements in national security are possible.

We can also secure a firm financial footing for Social Security (and Medicare) without choking off economic growth or curtailing our flexibility to pursue other spending priorities. Three actions are essential: (1) reduce entitlement spending growth through some form of means testing; (2) eliminate all nonessential spending in the rest of the budget; and (3) adopt policies that promote economic growth. This 180-degree difference from Mr. Obama's fiscal plan forms the basis of Sen. McCain's priorities for spending, taxes and health care.

The problem with Mr. Obama's fiscal plans is not that that they lack vision. On the contrary, the vision is plain enough: a larger welfare state paid for by higher taxes. The problem is not even that they imply change. The problem is that his plans are statist.

While the candidate is sending a fiscal "Ich bin ein Berliner" message to Americans, European critics of his call for greater spending on defense are the canary in the coal mine for what lies ahead with his vision for the United States.

Mr. Hubbard, dean of Columbia University Business School, was chairman of the Council of Economic Advisers under President George W. Bush.