Home > Budget, David Leonhardt, Tax Policy > Tax Cut Compromise and Political Ratchets

Tax Cut Compromise and Political Ratchets

If I had my way we would have just scrapped our currently inefficient tax system and started from scratch, but given the time to reach a deal this compromise between the White House and Republicans seems to have enough positive features to support. David Leonhardt correctly views this tax cut plan as an imperfect but necessary stimulus package.

Mr. Obama effectively traded tax cuts for the affluent, which Republicans were demanding, for a second stimulus bill that seemed improbable a few weeks ago. Mr. Obama yielded to Republicans on extending the high-end Bush tax cuts and on cutting the estate tax below its scheduled level. In exchange, Republicans agreed to extend unemployment benefits, cut payroll taxes and business taxes, and extend a grab bag of tax credits for college tuition and other items.

For the White House, the deal represents a clear shift in policy focus. Mr. Obama and Democrats spent much of the last year pursuing long-term goals like a health care overhaul and financial regulation, while hoping the economic recovery would continue. But with the recovery faltering and Republicans retaking the House, the administration is turning back to short-term job creation.

No, it doesn’t include spending projects such as a high-speed rail system or anything else but with those clearly off the political reality table, stimulus through tax cuts and credits was the best possible scenario for fixing our short term unemployment woes.

Many Democrats and those on the Left are upset at the President for giving so much to the GOP and to the wealthiest; I don’t share their anger since I don’t desire rich people to have to spend more money in taxes. Yet, I still have concerns. First, Paul Krugman is probably right about some of the “front-loading” problems with this.

Now we have unemployment insurance and payroll tax cuts for 2011, going away in 2012 — just in time to put the administration in big trouble as the election looms.

It’s not the political problem for me so much as the assumption that this will lead to a self-sustaining recovery.  Additionally, this bill gives tax cuts to everyone (especially rich people) so costs a lot of money and is going to add to our deficit. As I’ve argued before, this is a medium to long term problem, but it is still a problem. I hope another good compromise can be reached on dealing with our long-term budget but this tax compromise adds some obstacles.

The compromise doesn’t cost as much as it could because many of the cuts are again temporary. But “temporary” tax cuts often act like ratchets. It is very difficult to allow taxes to rise once they’re lowered, which is exactly the reason why this debate over the Bush tax cuts are taking place right now and why Bruce Bartlett previously worried about a payroll tax holiday as a temporary form a stimulus.

My point is that if allowing the Bush tax cuts to expire is the biggest tax increase in history, one that Republicans claim would decimate a still-fragile economy, then surely expiration of a payroll tax holiday would also constitute a massive tax increase on the working people of America. And what are the odds that the economy won’t still be fragile a year from now? Zero, I would say.

He’s right of course, but Bruce being a bigger fiscal conservative than I am places more emphasis on the long-term budgetary impact than on the short-term relief and stimulus the tax cut will provide. We should not ignore that concern however. Just look at the top marginal tax rate through recent history and it becomes obvious that even raising taxes on the richest among us is difficult.

Income of top 0.1% vs top marginal tax

Coupled with that we have the dueling and more consistent ratchet of spending.
















Only economic growth can do much to keep these forces from pulling everything apart. Eventually though it is not going to be enough and spending must be cut and taxes must rise. So let’s pass this compromise and start working on the next one.

  1. Bill
    December 8, 2010 at 8:07 pm

    The anger doesn’t stem from a thwarted desire to see rich people spend more money, it comes from the cost incurred onto our nation’s deficit without contributing much in the way of stimulus/job growth. In fact, according to Paul Krugman, “the CBO estimated that such an extension would reduce unemployment relative to what it would have been otherwise by 0.1 to 0.3 percentage points in 2011, twice that in 2012.” Au surplus, “the deal” offers a pittance back comparatively-$120 billion in a payroll tax cut; $56 billion in extended unemployment benefits; about $40 billion in extension of other tax credit. The rising deficit and the short term gains from this stimulus may make it more likely that entitlement programs will end up paying the price. Yep, the rich win, the middle class pays the price. At least we now know where the Republicans stand.

    • December 8, 2010 at 10:06 pm

      Well to a certain extent I agree. If I was crafting a bill on my own, I’d favor the rich paying more because of all those reasons you mentioned. But if giving rich people a bigger tax cut which is only slightly stimulative (and not is slightly depressing on growth) can convince enough senators to support an extension of unemployment benefits, a payroll tax holiday, an increase in the earned income tax credit (a great anti-poverty measure), and allows businesses to expense investment, which are all good ideas and more stimulative, I’ll take that deal.

      Imagine another scenario where we just extended the tax cuts for the under 250,000 brackets and increased them on those above and didn’t get the other stuff in the compromise. Clearly, the compromise is much better for our short-term economic problems.

      I’m not arguing this is the best possible bill for our economy or budget, but it might just be the best thing we could get considering the GOP is about to take over the House.

  2. Philippe
    December 9, 2010 at 3:40 am

    Interesting that the graph shows that the percentage of income going to the top 0.1% is the same today as it was in 1924.

    It is also interesting that in the Eisenhower 1950s, when well-nigh everyone was well off and had a job, the top marginal tax rates were 94%, and therefore confiscatory.

    Since it’s been shown that excessive income inequality between the rich and poor slows economic growth, and that more equality of income between the rich and poor results in higher economic growth, the solution to the current economic malaise is obvious.

  3. Bill
    December 9, 2010 at 5:38 pm

    Dan- Isn’t it a damn shame that we have to compromise what is best in order to achieve mediocrity? By fighting against this compromise, we stand up for what’s best and in the process shine the high beams on those who are willing to “take hostage” all that is right in order to win for pure selfish gain. By doing this-by taking the high road- we are giving righteousness the advantage it needs to fight against like battles down the road. By compromising now, we weaken this advantage and risk losing even more down the road. My fear is that what we will lose is social security and decent healthcare for all Americans.

    • December 9, 2010 at 7:08 pm

      It is a shame. If we knew for sure that not compromising now would lead to greater gains in the future you might have a case. But we don’t. I admire your principles here, but you’re sacrificing real benefits and allowing real harm in order to potentially get some undefined gain later.

      Not only that, but your scenario could backfire politically. Say we don’t pass this compromise and the GOP doesn’t bite on giving the Dems what they want (seems likely) and so all those taxes go up and we don’t get the added tax credits and investment changes. It seems quite possible that the economy would suffer as a result of that. Not only is that bad on in itself, but a bad economy leads to a weaker political climate for the President and his party. You’re fooling yourself if you think the electorate will only hold the GOP responsible for a failing economy – that would be contrary to all the political science we now have. Thus, we end up with a bad economy and the GOP probably gains even more seats and the presidency in 2012. Does that seem like social security and healthcare will be safer if that happens?

  4. Bill
    December 10, 2010 at 9:50 pm

    OK. True.The electorate in general does not have a memory. But here’s another problem I’m reading about: The short term gains we achieve through compromise are really short term-like only through 2011. Guess what happens when we slump back in 2012? Guess who gets blamed? Not sure if I see anything in the future that will carry us beyond these payroll cuts- which by the way, when they expire, will be seen as a tax increase(short term memory problem again)-and yet,if the re-extend, social security will suffer even a greater shortfall. This is bad. The backfire strikes both ways. What to do, what to do?

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