After thirty years of disinformation coming from the political right, the conventional wisdom has become that raising taxes in a recession is counter productive to an economic recovery. This near maxim is based in large degree on the history of taxation during the Great Depression. Hoover, of all people, is blamed for creating the "Great" in the Great Depression in 1932 by -- wait for it -- raising taxes in order to balance the budget. FDR is also blamed for stalling the recovery in 1937 by raising taxes to balance the budget. But to conclude cause and effect from these events is a leap to conclusion through being selective of evidence. There were other factors of equal or higher impact to the economy that were happening at the same time.
Hoover did more than double the marginal tax rate. The top bracket went from 25% to 64%. The bottom bracket went from 1% to 4%. But at the same time, widespread regressive consumption taxes were levied on things as common as chewing gum and as far ranging as ammunition. FDR raised the top tax rates to 90% at the same time he curtailed government spending on stimulus programs. So both tax increases were coupled with economic impacts affecting mostly the middle and poorer classes, regressive consumption taxes (which FDR retained by the way) and then a cut in stimulus spending. Non-Keynesian moves both.
At the very least one can hope that if the Bush tax cuts are allowed to expire, nobody in government will be stupid enough to compound whatever effect a small increase in middle class taxes has on the economy with a slew of regressive taxes and curtailment of stimulus spending. You'd like to think that nobody was that stupid, but then those two things are already happening irrespective of federal tax code. States who are obliged by their constitutions to balance their budgets are already rolling out regressive sales taxes, surtaxes on candy and alcohol and raising fees and use taxes. And with no second stimulus in the pipe, FDR's lamentable cutting off of stimulus in 1937 will slam the poor and middle class yet again.
What raising taxes on the rich will do is put some revenue in the pipe to support state budgets and forestall the shift of state tax burdens to the already less fortunate. What letting all the Bush tax cuts expire will do is the exact same thing with hardly any effect on the middle class and none on the poor who pay no taxes anyway. Half of Americans pay no taxes at all and are, in fact, dependent on social programs to make ends meet at all. This is because wages have not kept pace with inflation and poverty levels have risen sharply in the last decade. Government has stepped in and is literally subsidizing business and the rich by borrowing money to supplement the incomes of the working poor. Wal Mart is the prime example, it paying so little that its employees qualify for Medicaid. Wal Mart's health insurance plan is Medicaid.
The effect of letting all the Bush tax cuts expire on the pocketbooks of the middle class will be that their taxes increase by 2-5%. There is a doughnut hole for the very poor. With the loss of the 10% bracket the working poor will be subject to a 50% increase in their taxes amounting to as much as $700/yr for a married couple with a household income of between $15k ($0/yr) and $31k ($700/yr). If you make the national median income of $44k, your taxes will increase as much as $900/yr. If you make $100k, your taxes will go up as much $5k/yr if you have no deductions. These are serious numbers in terms of the economy and should be addressed. Unfortunately politics isn't good friends with analysis.
If the Bush tax cuts expire, some $370 billion dollars will be collected by government instead of being in the pockets of consumer's and the rich. That's 2.6% of GDP going to government coffers instead of being spent or saved by individuals. In light of the magnitude of these numbers, where that money goes is of serious concern. The answer is simple though. It's all spent by government and with certain foreign and corporate welfare dalliance's excepted, the money goes right back into the economy and shows up over a year in every paycheck or government benefit not matter who you are. Upset over taxation and spending at the level of the middle class is nothing but an argument over where and how the money is spent and is economically neutral. Even regressive taxes are beneficial if returned in benefits to the poor, but the problem is that they usually are not. Regressive taxes are meant most often to relieve the tax burdens of the rich, in some tax fairness melodrama that ignores a broader sense of justice.
What damages economies is when money is lost from the economy. In the case of the Great Depression and now our Great Recession, the rich were, and now are, at a peak in terms of how much of the nation's per capita income went to them. Now as in 1929, the rich took money out of the economy and "invested" it in non productive speculation apart from the real economy. Some $18 trillion in corporate cash are sitting on the sidelines waiting in vain for some market magic to offer some reason to re-enter the real economy. The notion that wealth is invested in economies and finances new homes and factories hasn't been true for over a century, not since Dow and Jones set up shop on Wall Street. The bulk of wealth now circulates in and out of stocks, bonds, currencies, commodities and hedge funds and will never see the real economies of the world again unless it is taxed back into it and spent by governments.
Higher taxes on the poor and middle classes don't damage economies except when they are levied in order to spare the rich from an increasing tax burden commensurate with their increasing share of wealth. In 1932 Hoover raised taxes on everyone but levied extra taxes on the working class. He did so in an effort to balance the budget and thus took money out of the economy in order to limit the liabilities of the rich who had appropriated too much for a healthy economy to sustain already. In 1937, FDR did the same thing and worse; he stopped government stimulus spending removing even more money from the economy, all in order to relieve the rich from returning enough money to the economy, from their takings, to keep it working.
WWII solved the problem of government not understanding on what a great world power economy is based. Wages doubled during WWII and the economy boomed for a generation. Nobody expected that kind of result it but Keynes. A world power economy is based on money in circulation and that is dependent on money in either of the hands of the wage earning public or the hands of government, both of whom spend what they take in. Eliminating the Bush tax cuts for the middle class will not harm the economy if it is not commensurate with tax relief for the rich. The only way to improve our economy is to tax the historic levels of wealth and return that wealth to the economy.
Continuing the Bush tax cuts will do nothing for the economy. Under Reagan/Bush tax policy the economy has gone from bad to worse and will continue to do so. Through it the rich are enabled to hoard more and more and the economic base and infrastructure of a world technology and economic power is eroded.
You, the middle class, will pay more if the Bush tax cuts are eliminated, but you will get that back in economic terms plus the 30% of tax revenue that 2% of the population now removes from the economy. For every dollar you pay in a tax increase, the rich will match it with 30 cents. It would be better to keep your 2-5% tax cut, but the GOP is not going to let you. Either way it's the best investment of which you might ever be a part.
The plight of the unemployed is the spit on which this tax question turns. Obama has already blinked because his tax policy advisors are Wall Street hacks. They have informed his view of the tax and economic landscape wrongly. Without the dire predictions on tax hikes to tilt the balance, the unemployed are a game of chicken as to public perception. If the Republicans want to govern, then let them offer a solution for the unemployed and see what the public thinks of their plan. I suspect the public will think that Republicans suck at governing.