Will Americans raise taxes to curb deficits? Oregon a test case.

A vote in Oregon Tuesday will resonate far beyond the Cascade Mountains as a gauge of whether Americans will support tax hikes to keep budget-strapped governments afloat.

The balloting – on measures to boost personal-income and business taxes – comes as the federal government and many other states are facing pressure to close budget gaps. And the measures, backed by Oregon Democrats, also come just a week after the Democratic Party was shocked by an election loss in the Massachusetts race for US senator.

The outcome in Oregon could tip either way, according to public opinion polls. As a generally Democratic state, and one battered more than most by the recession, it's an important proving ground.

Several states raised taxes last year on high-income earners, as the measure in Oregon would do. But in Oregon, the issue is directly in voters hands, not with the state legislature.

Pro and con

Supporters say a yes vote on Ballot Measures 66 and 67 would make the best of a bad situation. By raising more revenue, the state could close its budget shortfall without cutting into vital services. And they say the levies will fall on a small subset of Oregonians – businesses and people with income above $125,000 – the top 3 percent of Oregonians. Together, the measures would raise $727 million over two fiscal years.

Critics say the state hasn't yet made serious efforts to cut spending, and that the tax hikes on high earners and businesses will kill jobs.

"California has for years dumped its tax burden on those groups, falsely convincing the state's residents that government services are a free lunch because someone else pays for them," John Henchman of the Tax Foundation wrote on the group's website Tuesday. "Entrepreneurs and businesses are already taking notice of Oregon becoming tied with Hawaii for the highest state income tax in the country."

The Tax Foundation, generally a tax-hike foe, says that if Measure 66 passes, Oregonians will face the same top income tax rate as Hawaii (11 percent) as well as local income taxes that Hawaiians don't pay. Businesses, meanwhile, would face a general tax-rate hike, with a new mandatory minimum tax of $150.

Oregon a microcosm

The debate reflects a tough reality that spans much of the US. The economy needs jobs, and rising tax rates do little for job creation. But the recession has dealt a big blow to tax revenues – and many economists say that an economic downturn is not a good time to slash government spending.

A handful of states, from Oregon to Illinois, confront serious budget gaps. California recently saw its bond rating downgraded on fears that it will run out of money in coming months.

The federal government, while having no mandate to balance its budget, is also running up against political and economic constraints. President Obama has called for a partial spending freeze in Washington – part of a broader recalibration of his economic policies. But many budget experts say that move won't do much to close a yawning federal budget gap.

The president has taken positions similar to those by Democratic legislators in Oregon, whose plans paved the way for the vote-by-mail referendum that concludes Tuesday. Obama has favored a return to higher (Clinton-era) income-tax rates on top earners.

More recently, he's come out with a proposal to tax big banks. In part, it's a populist-tinted response to government bailouts of Wall Street. But fiscal experts say it also hints at growing pressure on Washington to find more ways to raise revenue.

Is taxing the rich enough?

In December, market strategists at Bank of America Merrill Lynch picked "rising taxation" as one of 10 big themes for investors to consider for the year ahead.
Yet tax hikes have a popularity problem with voters. Obama has pledged not to raise taxes on households earning less than 250,000. That's the same threshold as Oregon is using ($125,000 for individuals and double that for joint filers).

Tax experts say that, ultimately, tax hikes centered only on the rich won't be enough to restore fiscal stability.

Some economists worry that bond investors will begin to demand higher interest on US Treasury debt, unless the government shows signs of fiscal discipline.
Robert Shapiro, a former Clinton economic adviser, says the answer is one that has proved effective, for all its political thorniness, in the past: raising taxes and slowing the pace of spending.

He points to a December rise in interest rates on US Treasury debt as a troubling sign.

Foreign investors "are sending the White House and Congress a clear message," he wrote earlier this month for the Washington think tank NDN. "They think that Washington is taking on more debt than the American economy can handle."

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