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James Kwak

James Kwak

Posted: November 14, 2010 07:58 PM

There have been (admittedly unclear) indications from your administration that you may accede to the Republicans’ demand to extend the Bush tax cuts for everyone. I urge you not to do this.

The question is: Is it better to extend the tax cuts for everyone or for no one? The answer is to extend them for no one.

The Bush tax cuts have always overwhelmingly benefited the rich, not the middle class, and that is no less true today than when they were enacted. They were bad policy then and they are bad policy today. Extending the tax cuts would dramatically enrich the wealthy relative to everyone else. 65.5 percent of the total benefit would go to the top quintile by income, 26.8 percent to the top 1 percent, and 14.7 percent to the top 0.1 percent.*

Leaving aside discredited, Reagan-era theories about trickle-down economics, there are two main arguments for extending the tax cuts:

1. You shouldn’t “increase”** taxes during in tough economic times.

It is true that tax increases would have a modest first-order negative impact on economic growth. But that impact will be small (per dollar of net fiscal impact) for exactly the same reasons that tax cuts are a poor stimulus. The multiplier for tax cuts is far lower than the multipliers for virtually every other type of government spending, especially aid to state and local governments. In particular, the economic impact of tax increases is smaller when they go to the rich rather than the middle class, because the rich consume a smaller portion of their marginal income. In addition, letting the tax cuts expire would have positive second-order effects because it would improve the government’s fiscal balance, which is widely (though perhaps incorrectly) perceived as a source of risk to the economy.

Now, it might be preferable to extend the tax cuts only until the economy recovers and then let them expire. But that is probably politically infeasible, and in any case creates the risk that, at that point, Congress would then make the tax cuts permanent.

2. The tax cuts will help the middle class.

Yes, but they won’t help very much. If the tax cuts are extended, the average benefit for tax units (roughly speaking, households) in the middle income quintile will be $880 per year.*** By contrast, tax units from the 80th to 99.9th percentile will gain $6,094 each, and the top 0.1 percent–those with over $2 million in annual income–will gain $339,473 each.

Now, $880 means a lot to a middle-class family, and I will no doubt be called heartless for saying we should extend the tax cuts for no one rather than everyone. But letting the tax cuts expire will be better for the middle class, for one big reason–actually, 3.7 trillion reasons.

$3.7 trillion is the figure that is generally cited as the projected ten-year impact of the Bush tax cuts. Letting the tax cuts expire will eliminate $3.7 trillion from the projected national debt with one stroke. Why does this help the middle class? Because Social Security and Medicare are currently under assault. The national debt is being used as a bogeyman to frighten politicians (and the people who elect them) into agreeing to significant reductions to Social Security and Medicare.

Yet middle-class households need Social Security and Medicare far more than they need $880 of current-year income. Our country faces the very real threat of a retirement security crisis, since saving via 401(k) plans is shockingly low; in 2007, the average retirement account balance for a household where the head of household was between ages 55 and 64 was only $63,000 (Federal Reserve Survey of Consumer Finances, Table 6). That figure is surely lower today, after the financial crisis. And your administration knows very well the problem of health care cost inflation, having done more to attempt to solve this problem than any other administration, ever.

The single most important thing you could do to protect the retirement and health care security of the vast majority of Americans would be to let the tax cuts expire. The CBO (full document, Table 1-7) projects the cost of those tax cuts in 2020 at $368 billion, or 1.6 percent of GDP. The tax cuts mean the difference between a federal deficit of 3.0 percent of GDP (probably sustainable) or 4.6 percent of GDP (probably unsustainable). Removing that enormous wedge from the structural deficit would reduce the current pressure for “entitlement reform” and give the cost-saving provisions in your health care reform bill time to work.

In short, letting the tax cuts expire would be better for the middle class (and even more so for the poor–the lowest quintile would gain only $45 from extension), and for the country, than extending them for everyone.

Since you have a reputation for putting the welfare of the country before your political fortunes and those of your party, I hope this should be enough to convince you. But I believe this would also benefit you politically. If the American people want to know why their taxes will be higher in 2011 than 2010, this is what you can say:

“We face a grave threat to our nation’s future prosperity. That threat is a ticking time bomb set by my predecessor’s administration. In 2001 and 2003, my predecessor pushed through enormous tax cuts for the very wealthy, using small tax cuts for the middle class as a fig leaf. Instead of being honest about the impact this would have on our national finances, his administration timed the tax cuts to expire on December 31, so they could pretend they were smaller than they actually were.

“The Republicans want to let this time bomb explode. They want to make these tax cuts for the wealthy permanent, meaning that families making more than $2 million would save $300,000 in taxes, while ordinary families would save less than $1,000. This is at a time when our governments–federal, state, and local–lack the resources necessary to provide basic services to our citizens, secure our borders, educate our children, provide health care to the elderly, and invest in our economy.

“My proposal is to extend the tax cuts for the middle class, but not for the wealthy. The Republicans, who control the House of Representatives, insist on permanent tax cuts for the rich–tax cuts that load debt onto our children and grandchildren for decades to come. They are willing to sacrifice our future prosperity so that millionaires can save hundreds of thousands of dollars.

“I refuse to force future generations to pay for our own failure to make hard choices. I refuse to allow an enormous hole in the national budget that will threaten the long-term health of Social Security and Medicare. Because this is the price that the Republicans are demanding that I pay in order to extend the middle class tax cuts, all of the tax cuts will expire on December 31–under the law passed by the Bush administration.”

I’m sure your speechwriters, pollsters, and strategists can come up with something better (and didn’t you once say that you were a better speechwriter than your speechwriters?) than I came up with while lying in bed last night. But come up with something.

* All figures, unless otherwise noted, are from the Tax Policy Center. These figures also assume extension of the AMT patch. Note that these figures exclude the impact of making permanent the repeal of the estate tax (a permanent repeal is assumed in both scenarios); including that impact would skew the benefits even more heavily toward the rich.

** Of course, it is President Bush and the 2001 and 2003 Congresses that are increasing taxes on January 1, 2011.

*** The actual figure is probably slightly less than $880, since the Tax Policy Center’s analysis also includes extension of the AMT patch, so some of the $880 is due to the AMT patch, and some of it is due to extending the Bush tax cuts. Extending the AMT patch does not benefit the very rich (since they are above the AMT threshold in any case), so all of their benefits are due to extending the Bush tax cuts.

Update: After The Huffington Post featured this post, I realized I made a mistake in the fictional speech. The Republicans don't control the House yet, so theoretically the Democrats still have majorities in both chambers. But they still face the Party of No in the Senate, so practically speaking the Democrats cannot pass Obama's plan on their own. I suppose it is possible they could use reconciliation to get past the filibuster, but having just suffered a crushing loss in the midterm elections, the democratic legitimacy for such a tactic would be questionable at best.