To Extend or Not to Extend

As I write (Nov. 30, 2010) the Congress is about to start debating whether or not to extend all of the Bush era tax cuts or just a subset of them in order to deal with the deficit.  The Republicans want all of the current tax rates to be continued indefinitely, that is, until a real overhaul of the tax code could be tackled.  They appear to be willing to settle for a minimum of a two year extension.  The Democrats, led by President Obama, want the current rates continued except for those making over $250,000.  Senator Chuck Schumer, of NY, put forth the option to extend the rates for everyone making under $1,000,000.  The public, that is, us, prefer to extend them for everyone.


The reasoning underlying the Democrats views’ is suspect at best.  Obama says we can’t afford them, and it will only affect 2% of the taxpayers.  These 2% pay about 45% of all income taxes; the bottom 50% pay 3.5%.  Looked at another way the top 2% are paying 13 times as much as the bottom 50%.  As it stands the top 2% are certainly contributing heroically to funding the government.  Let’s look at the charge that we can’t afford not to raise the rates.  As is usual in government, when one is trying to make a point the cost/savings for multiple years are given because it balloons the figure.  We can’t “afford” maintaining the current rates for everyone else either, on their reasoning.   One factor, and it is a big one, that the Dems have overlooked is that those in the top bracket aren’t going to sit there to be shorn.  They will alter their behavior and reduce their taxable income.  In effect, the increased tax revenue will be less than estimated, by a long shot.  Further, in their efforts to reduce taxable income these individuals will spend resources to avoid taxes rather than devoting those resources to growing output.


We have the spectacle of columnist, Froma Harrop, shrilly saying  that;

“And what business is it of the chairmen — Erskine Bowles, a Democrat, and former Wyoming Sen. Alan Simpson, a Republican — to set an arbitrary (and low) maximum percentage on the tax revenue relative to gross domestic product that our society is allowed to collect? Their job is to find ways to bring down deficits. Period.”

She then goes on to say,

“For all the talk of the painful, painful(!) sacrifices needed to achieve the chairmen’s goal of reducing the federal deficit by $4 trillion through 2020, one thing should be kept in mind: Simply ending all the George W. Bush tax cuts would do the same thing. No one starved in the Clinton era. In fact, people did darn well then. That’s something for Democrats to think about now, before Republicans take over the House and start the fiscal voodoo dance all over again.”

You can’t make this stuff up.  I’m always amused by liberals/ progressives belief that 50.1% of us should be able to tell the other 49.9% what to do when it suits them.  The Bill of Rights were enacted precisely because the Founders recognized that the likes of Ms. Harrop were lurking out there.  Survey after survey shows that most Americans, 70% or more, believe that an individual’s total (State, Local, and Federal) tax burden shouldn’t exceed 25%.  These results hold for every subgroup out there .  Well, almost all.  I’m sure that the polls don’t have subgroups for: clergy (of any denomination); college English professors; carping liberal columnists; or unionized government employees.  These would demand expropriation of all income from those who made more than they did.  This is typically their definition of “the rich”.


Turning to Ms. Harrop’s comparison with the 1990s.  It is a totally inappropriate comparison.   Ms. Harrop confuses correlation with causation. To start with, the economy was still in the glow of the Reagan years.  The benefits of increased investment were still accruing.  Lawrence Meyers, who Clinton appointed to the Federal Reserve Board, had an economic consulting firm that analyzed the Clinton tax increases.  Their conclusion was that the economy grew slower and total taxes collected were lower than they otherwise would have been.  So, in fact, the Clinton higher tax rates weren’t a boon to the economy.  They didn’t appear to be a bad thing because of other decisions that were being made.  The two most important were the election of the Republican majorities in 1994 that slowed the growth of government spending and the slashing of the capital gains tax rate, against Clinton’s wishes, by the way.  These two events, against the backdrop of the Reagan growth agenda of the 1980s more than swamped the negative effects of the Clinton tax increases.


Sen. Schumer defends his proposal by falling back on the most naïve version of Keynesian economics.  He still believes in the concept of the marginal propensity to consume out of current income, fifty some years after Milton Friedman showed that people consume out of permanent income.  He seems to believe that if we just put more money into the pockets of people with high average propensities to consume the economy will grow.  Two problems with that: first, most obviously, we have been doing that for two years and have nothing to show for it; and second, what is being discussed by the Congress is not a tax cut but the prevention of a tax increase, which even Schumer realizes would be a disaster.


The Republicans push for maintaining the current taxes for everyone reflects the understanding that investment and job creation come from those making more than $250,000.  From a supply-side approach, the response to incentives is very disproportionately from the higher income small businessmen and other entrepreneurs.   Lowering marginal tax rates typically doesn’t cause a bank clerk, say, to increase their level of economic activity while it will to a business owner, or potential business owner.


Obama’s attitude was put on display during the campaign when he responded to Joe the Plumber, saying that he was for redistribution.  Raising rates for the so-called rich (m any two income families in NYC would fall into this definition of rich) appeals to his political orthodoxy which trumps his obligation create an environment in which the economy can grow.


When the dust settles where will we be?  I expect that the tax rates for all will be extended for at least two years and as a quid pro quo, unemployment benefits will also be extended for another 26 weeks. It is important to keep in mind that this will only prevent things from getting worse than they are.  In order for the economy to gain real traction, the plethora of mandates and regulations spewing out of the Executive branch must stop and many need to be repealed.  Simply put, regulations have the same effect as taxes but don’t get run through the government income statement.  The EPA, Health and Human Services, and the Dept. of the Interior are loose cannons that are circumscribing our daily lives to our detriment.  The Health Care bill needs to be rescinded and begun anew.  The financial reform legislation, another unread 2000+ page monstrosity, needs to be put in abeyance while cooler heads revisit every provision.   The energy drilling moratoria across the country need to be reassessed.


The vote on the tax rates will give a clear picture if the Congress got the message that the “Tea Party” sent on November 2.  If they didn’t the message , be prepared for another housecleaning in 2012.


posted by Jim


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