Tick Tock Tick Tax Tick Tock – Aug. 1, 2010

I wonder if the Administration and Congressional Democrats have the sense you get from those dreams where you are facing a big test for which you haven’t put in a lick of study.  For while this has been a very ambitious Congress, passing several pieces of major legislation – the $862 billion “stimulus”, Obamacare, financial regulation, the House version of Cap and Trade (none of which has the general populace very enthused) – there is one item that they have left undone, and it’s the one item that will get virtually every voter in a rage if they don’t get their act together and do something about it.  It’s also the one item they can’t kick down the field to deal with at a future date.  I refer, of course, to the expiration of the Bush tax cuts, scheduled to evaporate on January 1, 2011.

What could they have been thinking?  It’s not like this crept up on them.  This date has been baked in the cake since the cuts were passed in 2003.  Were they too busy remaking the US economy in Barack Obama’s image to focus on the calendar?  Back when they had an unassailable majority in the House and a filibuster-proof majority in the Senate, they could have done whatever they wished with these tax cuts.  But of course, then, the economy was on its back, and nobody wanted to be seen addressing the tricky issue of the tax cuts and their sell-by date.
Because Congress had – has – essentially three options.  First, they could do nothing, which has been the course of action so far, and let the tax cuts expire on schedule.  Problem with that is, that even though these have been ritually assailed as “tax cuts for the rich” by every Democrat and liberal voice since before they were passed, letting them expire will affect every single taxpayer, and the middle class taxpayer the most.  A family of four with an income of $100,000 will see their income taxes rise by some $4,000.  Even for the bottom scale of taxpayers, the rate goes from 10% to 15%, probably costing an average of $500; the child tax credit is halved, costing $1,000 for a two-child family; the marriage penalty comes back, costing another $600 or so.  So even at the bottom rung, taxes go up by over two thousand unaffordable dollars.  Democrats fearful of their hold on Congress do not want to be the ones to let these taxes go up.
Alternative number two is to extend all the Bush cuts.  The problem with this is that Congress actually has to pass and Obama has to sign a law to make this happen.  And the problem with that is two-fold: these folks have been chanting for years about how irresponsible the “tax cuts for the rich” were, so it doesn’t play well at home to deliberately vote to continue them.  The second problem is that the Obama budget, which already calls for a deficit of some $1.3 trillion, is counting on the revenue from at least some of these tax cut expirations.  So while the Republicans are flaying the Democrats alive for spending like they were sitting on the proverbial pot o’ gold, Democrats don’t want their response to be, more and greater deficits.
Thirdly, there is the chance of renewing some of the tax cuts but letting some of the rest (for “the rich”) expire.  This is the Solomonic “split the baby” decision that Obama wants to pursue.  And it fits with this Administration’s populism – more money for the little people, take it from the people who have it.  (Kind of like Willie Sutton’s famous quote – that’s where the money is).  But in the current environment, that can only happen if they can get enough Republicans on board to pass it.  And since any sort of comity between the parties has long since dissipated in the hard ball bullying that went into previous debates, there’s precious little chance of that.
Looming over all of this, of course, is the fact that the legislative calendar is rapidly dwindling.  The August recess is upon us, and after that most of official Washington is in full campaign mode.   Expect less than normal cooperation on hot button issues between September and November – and since normal cooperation is virtually none, that’s what will get passed on this. The political calculus for the Republicans is this: can they convince their voters that holding out, possibly resulting in across-the-board tax hikes, is the principled response when their opponents want to raise taxes on the rich?  Given the current anti-tax mood in the country, I think there’s a pretty good chance the voters will conclude that tax hikes on anybody is a bad idea, and that the Democrats are the ones to blame for the mess.  After all, they were in charge of Congress and they let this slide until their options were all but eliminated.
Best guess is that Congressional Democrats will swallow hard and vote for a limited extension – two years, perhaps – of the whole ball of wax, to be revisited down the road.  That way they can say they still intend to yank back those tax revenues “the rich” have been expropriating for their own enjoyment (that is to say, their own money), while at the same time keeping the big nasty tax hikes for the little guy from roaring back with a vengeance.  And I think Republicans will go along with this as well, figuring that over the next two years the political dynamic over this issue is more likely to move their way than the Democrats’.  Obama will have to deal with less revenue and therefore a larger hole in his budget, but that is something he can probably reconcile himself to.
Moreover, it is good policy to see these tax breaks extended.  Let’s start by saying that the Bush tax cuts were not responsible for the deficits that existed when he left office.  The clearest proof of that is that tax revenue went up dramatically in the years after the tax cuts – the economy grew by leaps and bounds, more people made more money on which they paid more taxes to the Feds even at lower tax rates.  The reason for the deficits was that spending went up even faster.
By extension of that logic, letting the tax cuts expire is bound to slow the economy.  Many of the most important tax cuts were taxes on capital – capital gains and dividends taxes, as well as the inheritance tax, which largely hits the owners of small businesses.  When the tax burden on capital is reduced, capital is more productive, which invariably leads to stronger economic growth.  If taxes on capital go up, the reverse will happen, as sure as night follows day.
To even contemplate letting those taxes go up when were are struggling with an unsteady recovery, with unemployment at 9.5%, and business owners reluctant to take risks, is just plain nuts.  And yet, here we have Press Secretary Robert Gibbs saying the other day, “I don’t know many economists who think that letting taxes on the rich go up will do much harm to the economy.”  That statement can only be true if Gibbs doesn’t know many economists.
But there is so much economic ignorance among Democrats.  Even among economists.  Even among Fed governors, for Pete’s sake.  Alan Blinder, a prominent Keynesian and former Vice Chairman of the Fed said in an op-ed this past week that deficit spending that puts money in ordinary people’s hands is a better use of “deficit” than giving tax cuts for “the rich” because the former is likely to be spent, the latter saved.  This is such shocking nonsense.  The money placed into one consumer’s hand comes from another, so the net increase to spending is likely to be marginal.  If it were otherwise, then the only thing standing between where we are now and full employment is our appetite for deficits.  It does indeed seem to be the White House’s philosophy that we can spend our way out of recession; based on current results, that theory could stand some review.
Tax cuts, particularly on taxes on capital, have the opposite result – they induce people to take risks, to start or grow businesses, to expand the national economic pie, to create jobs.  This dichotomy is akin to the old saying, “give a man a fish, feed him for a day, teach a man to fish, feed him for a lifetime.”  This government has contented itself with handing out lots of fish.
It is a fact that, regardless of the marginal tax rate, be it 70% or 30%,  the Federal government takes in between 18 and 20% of GDP in tax revenue.  That leads to two inescapable conclusions – first, that fiscal policy ought to concentrate on making GDP as large as possible; second, that government spending ought to hover in a similar range.
There is a much larger political issue here, one that we will come back to in a future post.  That is that there is an almost irresistible gravitational pull in representative governments toward increased spending.  Bringing money into home districts gets representatives elected.  So any efforts to reduce government deficits have to concentrate with almost maniacal focus on controlling spending.  Raising taxes to close budget gaps not only slows economic growth – it also ratifies the spending, and paves the way for more.
Meanwhile, back at the fray: This will be a fractious issue during the elections.  The Tea Party has set the stage – tax increases are toxic.  Democrats will find their class warfare rhetoric sounds clanging and hollow, while Republicans will hold out for economic growth and low tax rates, arguing that spending, not taxes, is the key to the deficit.  It’s hard to see how the liberal arguments will carry the day in these terms.
George Bush must be chuckling to himself off in his new home outside Dallas.  After all, even though he had to concede on the sunset of his tax breaks, he managed to schedule them to expire at a time that will most discomfit the other side.
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