As Republicans resurrect their favorite mantra in seeking to reduce taxes for the wealthiest Americans, the debate on the Bush tax cuts is escalating. It includes the economic debate over the impact of the tax reductions for high-income earners, and the political debate over the message that would be sent by either extending the cuts or allowing them to expire. Proponents must prove that the tax cuts will achieve their intended economic impact, and the tax cuts must not be mischaracterized for political purposes. With the midterm elections coming up soon, there is a partisan overlay to this issue that deflects bipartisanship, and the issue must be addressed in this context.
The Economic Debate: Are Tax Cuts for the Wealthy Effective?
The economic debate is essentially an anachronism, the latest progeny of the "trickle-down" principles of Reaganomics. Republicans suggest that high-income earners need the tax cuts to feel financially comfortable enough to invest in business, which then creates jobs and stimulates the economy. But this view is inherently flawed, and there are better alternatives to achieve the desired impact.
First, these tax cuts are based on a self-serving argument that was concocted years (maybe generations) ago -- by the wealthy, for the wealthy -- to justify their accretion of largesse. The "indirect benefit" notion is a messaging smokescreen, rooted in elitist ideology, which asserts that giving cake to the wealthy will enable others to gather some crumbs. If the ultimate objective is to help the non-wealthy, then such support should be provided to them directly.
Second, with or without tax breaks, high-income earners will invest where they find a good return-on-investment, which is driven by the business sector's ability to attract investment through sound business practices. High-income earners already can accelerate the economy through investment of their vast resources, and their desire for good investments is not dependent upon a tax cut. Putting more tax cut dollars in their hands does not mean that they have to invest their money at all, thus negating the "trickle-down" assumption. They make their choices based on what is best for them, not what is best for the economy.
Third, a tax break for the wealthiest 2% of people is not the same -- and not as effective -- as a tax break for businesses. The proposal is for personal tax cuts, to individuals, and most high-income recipients do not personally own a business. If the goal is to stimulate business and economic growth, then the tax breaks should be directed to small and medium sized enterprises (SMEs) that fuel local economies, and which would then be able to hire more employees and grow their business. For even greater impact, federal stimulus dollars can be applied to infuse capital much more directly into businesses and the economy.
Fourth, the suggestion that the Bush tax cuts for the upper 2% of earners cause sustainable economic growth is absurd. If they did, then our nation would not have faced economic collapse in 2008.
Tax cuts for the middle class and low-income Americans have a much more salutary effect on the economy. They boost consumption and broad-based consumer confidence, directly bolstering economic growth, which is why President Obama seeks to extend these tax cuts. Continuing tax breaks for the middle class would also spur investment, including in the business sector, with an economic impact like investment from high-income groups (i.e. less investment per capita, but from vastly more people), and more families would reap the benefits directly, rather than scavenging for crumbs.
Tax cuts for SMEs would also have a much more direct impact on economic growth than tax cuts for the wealthiest 2%. The latter would accrue to individuals who may or may not invest any of the money, and may or may not invest it in American-owned companies. A tax break for SMEs would directly accrue to businesses that could then hire employees, purchase capital goods, extend the reach of their marketing efforts, and take other actions that would directly grow the economy.
In short, the Bush tax break for high-income earners is bad economic policy that does not achieve its stated objectives. There are more effective means toward economic and job growth.
The Political Debate: Would it Be the End of a Tax Holiday or a Tax Hike?
The Bush tax cuts were designed to expire. Even many Republicans realized it was bad policy to make them permanent, causing President Bush to institute them through Budget Reconciliation, which limited their duration to ten years. So, since they would need to be reauthorized in order to continue, would the decision not to continue them be sound fiscal policy and social fairness, or a tax hike?
Republicans suggest that a decision not to extend the tax cuts for high-income earners would amount to raising taxes. Democrats suggest that the tax cuts were designed to expire, and that their expiration is merely the end of a tax holiday.
First, since these tax cuts were only a temporary benefit, arguing that they must be extended is tantamount to trying to create a de facto entitlement for high-income earners. The proposition of creating an entitlement for those who need it the least is prima facie unfair, unnecessary, and presents a stark irony (some might say inconsistency) in light of pervasive Republican aggression against entitlement programs for disadvantaged Americans.
Second, the business and investment communities quest certainty for planning and fiscal management. As Mayor Bloomberg put it recently, "...uncertainty is not good. You don't make spending decisions, investment decisions, hiring decisions... when you don't know what's going to happen." Yet, the tax cuts for high-income earners provided such certainty, i.e. that the tax cuts would expire at the start of 2011. This was clear in the law that created them, and it enabled the beneficiaries of the tax cuts to plan accordingly Belief that the tax cuts would continue beyond 2010 is somewhere between wishful thinking and pure fantasy. Thus, it is a fallacy to suggest that not extending them equates to a tax hike.
Third, many who are calling for the extensions of the tax cuts for the upper 2% of earners are the same people who object to rising government spending by agencies that have their budgets increase but never decrease. They complain that a new, temporary budget increase does not entitle the agency to expect the same level of funding (or more) in the future. Yet, when it comes to tax cuts, they violate their own principles, by arguing that a temporary tax break should create an expectation of permanence.
Fourth, the Bush tax cuts triggered the decimation of the 2000 budget surplus and the upward spiral of the annual deficit, surpassing a trillion dollars by the end of the Bush presidency. Many opponents of the Bush tax cuts cited the impact that such an enormous giveaway would have on the national debt, and hence, on the American economy over the long term. With debt reduction being so urgent now, continuing to drain the federal treasury by giving tax cuts to the highest income earners -- which would necessitate borrowing to pay for them -- would be irresponsible at best. In fact, it could destabilize our economy for decades to come, as an exorbitant share of federal dollars are allocated to paying the debt service, rather than providing services to Americans. Even the proponents of these tax cuts recognize the debt problem and call for deficit reduction. Their call for tax breaks is inconsistent with their own stated priorities, thus illuminating the purely political objectives of alleging a tax hike.
Therefore, it is illusory to suggest that honoring an intended sunset of a tax break would amount to a tax hike, and a claim to the contrary is a mischaracterization. A tax holiday was given to high-income earners, and insisting that it be extended is like requiring Macys to extend their Presidents' Day sale.
The Bottom Line
Congress may still choose to offer new tax cuts to high-income earners. But it must first be fully satisfied that doing so would stimulate the economy in the manner and to the extent that its proponents allege, and that there are not other alternatives that would be more effective in achieving the desired results. This is a high bar to hurdle. If the economic and political factors are applied objectively, these tax cuts will fall short.