Tax Cut Ironies

Wednesday, 08 December 2010 12:10 By James Kwak, The Baseline Scenario | News Analysis | name.

Tax Cut Ironies
President Barack Obama is reflected in a mirror as he meets with newly-elected governors at Blair House, December 2, 2010. (Photo: Lawrence Jackson / Official White House Photo)

From The New York Times:

“Congressional Republicans in recent days have blocked efforts by Democrats to extend the jobless aid, saying they would insist on offsetting the $56 billion cost with spending cuts elsewhere.”

Instead, as it turns out, they agreed to offset the cost with tax cuts elsewhere.

Still, though, I place the blame for this one squarely on the White House. The Republicans are just doing what Republicans do: arguing for lower government spending and lower taxes. The fact that they justify the former by saying it will cut the deficit and the latter by saying it will stimulate the economy (when you could just as easily switch the arguments and make them point the other way) is just a detail.

As I’ve said before, the Bush tax cuts were always bad policy.* After the last election, President Obama will be able to accomplish precious little. But he could easily have killed the Bush tax cuts and thereby done more good for our nation’s fiscal situation than anyone will be in a position to do for many years to come. Killing the tax cuts would alone reduce the national debt by roughly as much as the deficit commission’s entire proposal. And killing the tax cuts was the path of least resistance. Obama could have done it by doing nothing. Or he could have done it by taking a strong negotiating position and being willing to walk away from the table.

(Note to Barack: If you want to win a negotiation, you have to be willing to walk away. Take my daughter. If I threaten her with a three-minute timeout, she says, “I want a timeout for eight hours!” If I threaten to take away an episode of Dinosaur Train, she says, “I don’t want to watch Dinosaur Train ever again!” You have two daughters, right?)

Instead, we got a two-year extension as part of an overall package that adds $900 billion to the debt.

Now, Ezra Klein, whom I agree with more often than not, says, “the White House and Congress are right to make the deficit less of a priority than economic recovery.” Well, sure, in principle. But this deal isn’t justified by that principle for two reasons. First, as Paul Krugman pointed out, a two-year extension will reduce the unemployment rate by 0.2 to 0.6 percentage points. Yes, that’s hundreds of thousands of jobs, but it’s at a cost of hundreds of billions of dollars. And at the current course and speed, those hundreds of billions of dollars will, in the long term, get taken away from the middle class in lower Social Security and Medicare benefits. The reason it’s just 0.2-0.6 percent is that tax cuts, once again, are a lousy form of stimulus. According to Mark Zandi (via Menzie Chinn), the multiplier for the Bush income tax cuts is 0.29 and the multiplier for accelerated depreciation is 0.27.

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Second, this can no longer be considered a two-year tax cut. This year, the Democrats gave in to the framing that letting the cuts expire would be a tax increase. President Obama has already nailed himself to the cross of “stop[ping] middle-class taxes from going up.” With that on his resume, how is he going to flip-flop and let those taxes go up in 2012? He won’t win a vote to cut taxes just for the middle class with fewer Democrats in Congress than he has now. So if he wants to preserve the middle-class tax cuts, he’ll have to compromise again.

And Obama will no longer be able to say the tax cuts were a mistake made by President Bush that he was letting expire. Now he owns the mistake. This is a long way of saying that this isn’t a two-year tax cut to stimulate the economy (with a 0.29 multiplier, remember) in a recession. It’s a wedge of about 2 percent of GDP that is part of the structural deficit for the foreseeable future, just like the AMT patch that magically keeps getting extended.

Sure, they might not be extended in 2012. But I fail to see how the politics will be any different. “I protected you from a tax increase in 2010, but I’m raising your taxes now because . . . because . . . suddenly I care about the deficit . . . and we’re not in a recession anymore.” Yeah, right. By comparison, the message this time would have been easy: “I and the Democrats in Congress supported a bill to keep your taxes low. The Republicans blocked it because they insisted on tax cuts for the rich. Blame them.” So the tax cuts might not be extended, but you could also say that Congress will vote to raise taxes. Not likely in either case.

So finally, you have to ask, what does Barack Obama want? Does he really like most of the Bush tax cuts? Does he really think the bulk of the tax cuts are good for the country, and that going along with the tax cuts in the top brackets is a reasonable price to pay to keep them?

* How bad? Here’s one example. In order to pass the bill using reconciliation–the first time reconciliation was ever used to pass a deficit-increasing bill–they had to limit the ten-year cost of the bill. One way they did that was by adding a provision that allows upper-income taxpayers, in 2010, to convert their traditional IRAs to Roth IRAs. This is unambiguously good for upper-income taxpayers, because it’s optional, so you can decide if you want to do it. So in the long term, it will result in lower tax revenues. But it artificially juices tax revenues in 2010, because when you convert you have to pay tax on the conversion amount now. That increased the amount by which they could cut taxes elsewhere in the bill. So, as my tax casebook puts it, the bill uses tax cuts for the rich to fund more tax cuts for the rich. 

Last modified on Wednesday, 08 December 2010 12:30