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Neil H. Buchanan

Extending the Bush Tax Rates for High-Income Earners: The Weakness of the Economic Arguments Explains the Ridiculous Political Posturing


Thursday, September 16, 2010

In the last few weeks, the debate over the Bush tax cuts has heated up in Washington. As many readers may know, the tax cuts enshrined in the 2001 tax bill were -- for reasons of political expediency at the time -- set to expire at the end of this year. This looming expiration date creates a fascinating partisan strategic problem, because neither party wants to allow all of the tax cuts to expire. With the default option of doing nothing apparently off the table for both sides, the question is whether the Democrats can force the Republicans to vote for a bill that would extend the tax cuts for all but the richest two percent of taxpayers, or whether Republicans can force Democrats to extend the current, lower rates for everyone, including the wealthy.

This promises, therefore, to provide truly entertaining political theater. Underlying that theater, however, is the question of which party's political preference is actually the better policy choice. Whereas, on other issues, both parties might have a colorable argument on the merits to support their political position, in this instance there really is no case to be made for the Republicans' position -- as I will explain.

In this column, I will examine the arguments in favor of extending the Bush tax cuts for the richest two percent of taxpayers, showing that none of the proffered arguments withstands critical scrutiny. In fact, the economic arguments are so weak that they have essentially morphed into political arguments -- statements of ideological commitment, rather than reasoned analyses of what is truly at stake for the country and the economy.

Taxes, Deficits, and Hypocrisy

As many analysts have noted, and as the White House and its allies have happily pointed out, the Republicans' embrace of the Bush tax cuts is completely inconsistent with the anti-deficit mantra that they have repeated ever since President Obama took office. Indeed, one would think that people who so thoroughly believe that deficits are bad would not only allow the Bush tax cuts for the wealthy to expire, but also would allow taxes to rise automatically for the remainder of the country as well. After all, the estimated ten-year increase in the deficit due to the extension of the top-2% tax cuts is $700 billion; and the cost for extending all of the tax cuts is about three trillion dollars. Yet Senator .Jon Cornyn (R. Tex.), among others, has insisted that it is never appropriate to offset tax cuts, even if the deficit rises.

Republicans claim that the real problem is spending, and say that they do not want to enable the government to continue to grow. This, of course, means that they really were not telling the truth all those times that they railed against deficits, because they are now saying that they would choose to increase the deficit -- at least temporarily -- as a strategy to reduce the size of government. Even so, charges of political hypocrisy are standard fare in Washington, and no one seems to believe that there is a price to be paid by those who opportunistically shift positions in response to political expediency.

The non-political question is whether increases in the deficit are always bad. I have consistently taken the position, in FindLaw columns and elsewhere, that federal budget deficits are not necessarily a bad thing. For instance, if deficits result from increased spending and tax cuts that are enacted to fight a recession (through, for example, an appropriately-large stimulus bill), then deficits are good in the short run. In the long-run, deficit spending is also good economic policy, so long as the deficits are used to finance growth-inducing spending projects or changes in tax policy.

Extending the high-end Bush tax cuts, however, achieves neither of those goals. As I will explain below, tax cuts for the rich do nothing at all to end the recession, and they do nothing at all to increase economic growth.

Lower taxes for the rich do, however, worsen the extremely unequal distribution of income in this country. Since the beginning of the Reagan era, average real income per person in this country has gone up by more than 60%, yet the median income in the country has been virtually unchanged. This is because the impressive increases in income have all accrued to the wealthiest Americans.

Therefore, even for someone who does not take an absolutist position that deficits are always bad, this method of increasing deficits is clearly a bad idea. The lower taxes enjoyed by the wealthy will certainly help the lucky few who receive them, but the country as a whole will be worse off -- especially because those tax cuts will continue to worsen the deficit after the economy finally emerges from the Great Recession.

The Weak Economic Case for Extending Tax Cuts for the Rich

It is, as noted above, the unified Republican position that all of the tax cuts should be extended. Moreover, a small number of Democrats -- who are either ideologically conservative, or from swing districts -- have also joined the fray, drafting a letter to send to Speaker of the House Nancy Pelosi requesting that all of the tax cuts be extended.

The arguments offered in that letter, as well as the arguments that have been made by others who would extend the tax cuts for the rich, are astonishingly weak. Here is a list of the four arguments that have been made most frequently, and the reasons that each of those arguments is so unpersuasive:

(1) Businesses Need Certainty -- The letter to Speaker Pelosi argues that "in times of economic recovery it makes good sense to maintain things as they are in the short term, to provide families and businesses the certainty required to plan and make sound budget decisions."

But this is not an argument in favor of extending any of the tax cuts, much less the tax cuts for wealthy Americans. Because of the looming December 31 expiration of the tax cuts, there is already uncertainty in tax policy. If the most important thing is merely to let everyone know what will happen on this issue, then it only matters that something be done quickly about taxes, not what is done. In fact, if it is so important for this uncertainty to be resolved quickly, then the smart thing for these dissenting Democrats to do is to stand with their party and end the debate. Sending around a letter for signatures only extends the process.

(2) Tax Cuts Should Not Lapse During a Recession -- There have been several variations on the theme that "now is not the time to allow taxes to rise."

The more general version of the argument simply says that the economy is too weak to withstand any tax increases. If that were true, however, it becomes especially difficult to explain House Minority Leader John Boehner's argument that Democrats should agree to "pass legislation immediately that cuts spending to 2008 levels for the next year." If the economy is so weak -- and it is -- then the surest way to weaken it further is to cut back spending. There are people who receive that spending as their incomes, and losing that income would mean that they would become part of the unemployment problem -- which would, in turn, mean lower spending on groceries and rent, weakening the economy still further. Even if the reduced spending is paired with tax cuts, moreover, the only way for that combination of policies to have a net expansionary impact would be to have much bigger tax cuts -- and thus much bigger deficits.

A more specific, and novel, version of the "not during a recession argument" was offered in the dissenting Democrats' letter: "While those in the highest-income brackets comprise only 2 to 3 percent of American taxpayers, economists estimate that they are responsible for 25 percent of national consumer spending. As 70 percent of our economy is driven by consumer spending, this is not the time to jeopardize further growth." There is, however, a reason that this argument is novel: It is silly. It does not matter how much spending rich people do. It only matters whether their spending will change significantly in response to higher tax rates. There is simply no serious argument that an increase in a wealthy person's tax rate from 35% to 39.6% would cause him or her to reduce his or her consumption spending. One of the best things about being wealthy, after all, is the luxury of not being on the edge financially -- indeed, far from it. Small or medium-sized changes in after-tax income do not change consumer spending by the well-off.

(3) High Tax Rates Always Harm the Economy -- Another all-too-familiar argument against higher tax rates is not contingent on the state of the economy. This argument is based on the idea that high tax rates cause wealthy people to change their behavior, reducing their wealth-producing activities in response to lower expected returns from those activities. Whatever the tax rates are for the wealthy, therefore, it would be better if they were lower still.

This argument proves only one thing: Trickle-down economics is alive and well. The theoretical case for this claimed trickle-down effect is ambiguous, however, and the evidence is contestable, at best. Indeed, the bulk of the evidence strongly suggests -- to the contrary -- that wealth creation is not responsive to tax rates, especially for such small changes in tax rates as are at stake in the current debate.

(4) It's All About Small Businesses -- Both parties are deeply committed to the rhetoric of small business, apple pie, and Americana. This week, for example, the White House is trying to push through a bill to improve lending to small businesses. Meanwhile, politicians of all stripes repeat familiar claims about small businesses being the source of most job growth.

And in the debate over the tax cuts, the Republicans have tried to claim that small businesses would be uniquely harmed by the expiration of the Bush tax cuts for the wealthy, presumably because those rates would harm the wealthy owners of prosperous small businesses.

The evidence is clear, however, that small businesses would not be affected by these tax changes, either because they are set up so that the Bush tax cuts simply do not affect them, or because their income is too low to be affected by the increases in the top tax rates.

Although neither party wants to admit it, moreover, small businesses are not all that they are cracked up to be. Most such businesses fail in a very short time, especially in a weak economy, meaning that they destroy as many jobs as they create -- or more. Most offer low pay, and virtually none provide benefits for their employees. If the economy is going to recover in response to Americans' feeling economically secure, inducing them to spend again, this is not the economic sector on which to hang one's hat. Small businesses, on the whole, are anything but secure and stable.

In short, the argument over the extension of the Bush tax cuts has become political theater in large part because it cannot be anything else. The non-political arguments all point only in one direction: Allow the cuts to expire for the top two percent of Americans. Lacking a serious argument, proponents of regressive tax cuts are left with nothing to say. But at least they say it loudly.

Neil H. Buchanan, J.D. Ph. D. (economics), is a Visiting Scholar at Cornell Law School, an Associate Professor at The George Washington University Law School, and a former economics professor.

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