Increasing Productivity is Key to Generating Federal Revenue

"Cut spending and raise taxes" has long been the only way the United States government and the American public have conceived of raising federal revenue and decreasing the budget deficit. And while these methods undoubtedly raise revenue, they are not the only way to do so. The federal government needs to consider increasing productivity as a reliable alternative to taxation.

In their annual report, Options for Reducing the Deficit, the Congressional Budget Office (CBO) studies over 75 solutions to raise federal revenue. These options, ranging from tax hikes to cutting federally funded programs and subsidies, produce revenue increases from less than $100 billion to over $1 trillion over the next ten years. Table 1 displays several tax reforms introduced by the report designed to increase federal revenue. The CBO considers the dynamic changes that have occurred with previous increases in tax rates in its calculations, such as shifting income or changes in work patterns.

Table1: CBO tax reform options (in billions of dollars)

Type of Tax	Increase in Federal Revenue 2023-2032
Increase labor productivity by 3.4 percent annually	1,537
Raise all tax rates on ordinary income by 1 percent	1,083
Raise tax rates on ordinary income in the four highest brackets by 2 percent	501
Raise corporate income tax rate by 1 percent	129
Raise tax rates on long-term capital gains and qualified dividends by 2 percent	102

The effects of these taxes are variable. An increase in all income tax brackets will apply to the taxable earnings of every worker, regardless of pay, likely putting a greater strain on lower-income workers. In contrast, raising tax rates in the four highest income brackets or raising rates on capital gains will place the direct burden of the tax solely on high earners.

What if, instead of raising tax rates, we increased the pool of money-gross domestic product (GDP)-that gets taxed? This is where economic growth and labor productivity come into play.

GDP can grow in two ways : more hours worked or higher productivity (output per hour worked). Throughout history, productivity has increased through the development and adoption of new technologies, from the cotton gin in the late 18^th century to artificial intelligence today. The potential of these new technologies to increase productivity and economic growth is a reason for optimism, as it can significantly expand the tax base and improve fiscal policy.

Labor productivity is projected to grow 1.4 percent annually over the next two decades. At this rate, GDP will increase to $31 trillion, and federal revenue will increase by $580 billion between 2023 and 2032 (assuming that federal revenue is 16 percent of the total GDP). If labor productivity continues to grow at this rate, federal revenue will increase by $1.9 trillion by 2049.

But what if labor productivity grew at 3.4 percent, a rate enjoyed by the United States for much of the 1960s? As shown in Figure 1, federal tax revenue generated through 3.4 percent annual productivity growth far exceeds that generated at a 1.4 percent growth rate. By 2032, federal revenue will increase by $1.5 trillion. By 2049, it will increase by $6.1 trillion.

Figure1: Federal tax revenue from different productivity rates

Increasing productivity has also been found to increase real median income across all economic groups, disproving the theory that productivity benefits are only felt by top earners. In a 2014 report revision, Thomas Piketty and Emmanual Saez find that increasing productivity benefits not just the top earners in the economy but all workers. They find that between 1979 and 2014, real median income grew by 33 percent on average.

Increasing federal revenue is essential to decreasing the deficit and funding social programs such as welfare, Medicare, and infrastructure investments. While increasing taxes is a viable way to finance these investments, it should not be viewed as the only option. Increasing labor productivity through the development and adoption of new, innovative technologies will drive economic growth, as it has for decades, and it should not be ignored as a valuable way to increase federal revenue.

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