Should the Bush Tax Cuts Expire? Two Opposing Views
Hold off on tax increases while the economy lags
Eventually, taxes will need to rise on America's wealthiest families and cuts will have to be made to entitlement programs. But now is not the time.
Aug. 7, 2010
Tax cuts enacted under the administration of President George W. Bush expire Dec. 31. If Congress does nothing, taxpayers will be slapped with huge increases. Neither political party wants that to happen. And in an election year, it won't.
But an intense debate is stirring the waters of the Potomac over whether to hit wealthy Americans with a tax hike. President Barack Obama proposes extending the Bush tax cuts for the middle class but allowing them to expire for the richest Americans - those earning more than $250,000 a year. Republicans want to extend the tax cuts for everyone.
We think the wealthy should pay more - but not yet, not while the economy remains so sickly. We favor extending the Bush tax cuts provisionally for one year for all taxpayers.
With an anemic economic recovery looking paler by the day, jacking up income, dividend and capital gains taxes is the wrong medicine. We favor reviving the estate tax, although Congress will need to do some tinkering. The tax rate called for under the current law is too high - at 55% - and the exclusion too low - at $1 million. Congress also must patch the alternative minimum tax before year's end so that it doesn't unfairly harm the middle class.
The central concern right now is the economy's health. And the latest checkup was unsettling.
According to the Commerce Department, the economy grew weaker in the second quarter as shoppers pinched pennies and businesses pulled back from restocking inventories. Consumers, the main drivers of growth, remain wary.
Over the longer term, there is no question that taxes on the wealthy will need to rise. Taxes probably will need to rise on the not-so-wealthy, too, although you'd never know it from listening to politicians from Obama on down. They know the deficit cannot be tamed any other way but are afraid to say so. Particularly in an election year.
For the current fiscal year, the federal government is expected to run a deficit of $1.4 trillion, a number that would have been unthinkable just a few short years ago. Without changes in tax and spending policies, trillion-dollar-a-year deficits are expected for another 10 years, followed by a tidal wave of entitlement spending on Medicare, Medicaid and Social Security that will swamp the nation's fiscal boat.
Some combination of tax increases and cuts to entitlements - which now represent 40% of the budget - are essential.
But fairness also must be restored to the tax code. The gaps between the richest 1% of Americans and the middle and poorest fifths of the country more than tripled from 1979 to 2007, according to statistics released in June by the Congressional Budget Office. During that time, the average after-tax incomes for the top 1% rose by 281% on an inflation-adjusted basis. That's $973,000 per household. The middle fifth of American households saw their incomes rise only 25%, or $11,200, over those years.
The Bush tax cuts were enacted in response to the recession that followed hard on the heels of the terrorist attacks on Sept. 11, 2001. But the tax cuts weren't repealed when the economy recovered or when Bush pursued questionable military adventures in Iraq and Afghanistan and pushed through an expensive new Medicare drug entitlement as he sought re-election in 2004. All of it went on the national credit card. It was incredibly irresponsible behavior.
In finding a way forward, those who want to raise taxes on the wealthy this year offer several main arguments:
Allowing the tax cuts to expire would raise revenue.
The Obama plan would raise about $55 billion to $60 billion, but that wouldn't wipe out the deficit by a long shot. In fact, extending the middle-class tax cuts, as Obama proposes, and preventing the alternative minimum tax from creeping into middle-class tax brackets would cost $2.5 trillion over a decade. As columnist David Wessel of The Wall Street Journal notes, that is about 85% of the cost of extending all the tax cuts.
It would send a symbolic message to our trading partners that the country is getting its fiscal house in order.
Without a comprehensive plan to reform the tax code to make it fairer and a plan to rein in entitlement spending, our foreign partners are unlikely to be persuaded of our thrift.
It won't hurt the economy; the rich will never miss the money.
This argument presumes that the rich don't spend money - that they hoard it. When the rich invest, companies use the money raised through capital markets to buy new plant and equipment and to hire workers. Money invested isn't spent during the first round of consumption, but it is spent during later rounds.
A study by the Harrison Group found that the discretionary budget for wealthy Americans over the next year was expected to rise by $56 billion - about the size of the tax hike expected to hit them.
In addition, a tax increase for upper-income brackets would hit some small businesses, although the size of that hit is debatable.
The Joint Committee on Taxation found that only 3% of Americans who report small business income through their individual returns would be affected by the Obama administration's tax plan. Yet those 3% represent about half of all small business income reported on individual returns. The Tax Policy Center found that of the wealthiest tax filers - the top 1% - about 25% earned more than half their income from businesses.
Raise taxes on the rich and redirect the money to more productive uses.
This is the strongest argument for raising taxes on the wealthy now. Analysis by Mark Zandi, chief economist at Moody's, shows that government spending on unemployment benefits, food stamps or grants to states in fiscal distress has a bigger bang for the buck than tax cuts. The money gets into the economy faster. More stimulus is appropriate, especially if the economy continues to lag. But a tax hike now is at cross purposes with priming the pump. Even Zandi favors phasing in increases for wealthy taxpayers.
The economy needs at least another 12 months to get on its feet. In the meantime, lawmakers should begin a serious discussion about reforming the tax code. The goal should be a leaner, fairer approach that raises more revenue for federal accounts and does so by leaning more heavily on the people who can afford to pay.
But for now - wait. A tax on the rich right now would be one more drag on an economy that already is carrying a lot of baggage.
Congress is gearing up for a battle that will have profound economic and budgetary ramifications: Should the Bush tax changes expire as scheduled under current law, or should there be a partial or full extension?
While some of the changes for the middle class have boosted take-home pay for many families, the tax cuts for the wealthiest are both poorly designed short-term stimulus and ineffective long-term economic policy.
The tax changes enacted in 2001 and 2003 by President George W. Bush and a Republican-led Congress were loaded with gimmicks, the benefits were skewed heavily toward the wealthy, and they added trillions of dollars to the national debt.
Some have argued that because the economy remains weak, the tax changes should be extended in their entirety, either permanently or temporarily. While it's true that tax cuts can provide an economic boost, it is also true that not all tax cuts are equal.
Increasing the take-home pay of low- and moderate-income families will lead to more spending and a boost in demand for goods and services and, thus, more jobs. By contrast, tax cuts for the wealthy are more likely to be saved, providing a relatively ineffective response.
Economist Mark Zandi of Moody's Analytics estimates that every dollar spent making the Bush income tax cuts permanent generates only 32 cents of economic activity. Comparatively, every dollar spent on unemployment assistance generates $1.61 worth of economic activity, a dollar of spending on infrastructure yields $1.57 and a dollar in assistance to states to prevent layoffs of teachers or first responders yields $1.41. Tax cuts for the wealthy are simply not a good way to stimulate the economy.
A much more economically sound approach to supporting the economy would be to let the tax cuts expire for those at the top of the income scale and to use the revenue to fund more cost-effective job creation policies.
President Barack Obama has proposed repealing the reductions for those making over $250,000, and even a small portion of the revenue generated - some $629 billion over the next 10 years - could be used to fund supports for those hardest hit by the recession, to aid state and local governments, to fund transportation projects and even to help localities directly employ some of the 14.6 million people who are ready to work, while also reducing the deficit in the long-run.
Simply put, the cost of extending the upper-income Bush tax cuts, in both dollars and lost opportunities, is unacceptably high.
Many have argued that the tax cuts are good for the economy over the long term. Lower tax rates for the wealthy might increase incentives to work or invest more - and these benefits might eventually trickle down to average families. The economic record tells a different story. Of the 10 economic expansions since 1949, the expansion from 2001 through the end of 2007 ranks dead last in terms of economic growth, national investment, employment and employee pay.
The Bush-era tax policies did not lead to economic progress. In fact, the opposite was true. Why should we expect a different outcome looking forward?
Finally, some have argued for only a temporary extension. As a matter of good governance and good tax policy, major structural changes to the tax code should not be enacted on a temporary basis.
A one- or two-year extension of the cuts for the wealthy is a poorly designed stimulus and would set a fiscally irresponsible precedent for our nation's long-run budgetary planning. Congress should extend permanently reductions for the middle class and let the other provisions expire.
We need to streamline and modernize the tax code, not perpetuate a failed system.
Andrew Fieldhouse is a federal budget policy analyst and John Irons is the research and policy director, both at the Economic Policy Institute.