Other than pro football or maybe big-time wrestling, nothing stirs the passion pot more than the subject of taxes.
It doesn’t matter whether you are a Republican, Democrat or some type of political hybrid. Everyone hates taxes. While most reasonable folk concur that they are a necessary evil, no one can see eye-to-eye on who should be taxed and how much. If you throw former George W. Bush into the mix, the fur really starts to fly.
Truth be told, I was no fan of W. Eighteen months after his term in the Oval Office ended, I’m still not. But as a taxpayer, I loved his tax cuts.
With the Bush tax cuts set to expire at the end of this year, the debate over their fate has been heated.
The cuts reduced tax rates across the boards on income, dividends and capital gains. Eventually, the provisions eliminated estate taxes while lowering the tax burdens on married couples, parents and the working poor. It also increased tax credits for education and retirement savings.
President Obama’s proposal would extend most of these reductions indefinitely. On the chopping block would be the elimination of the tax cuts for individuals making more than $200,000 and families that earn in excess of $250,000 a year.
The most commonly heard arguments against extending the Bush tax cuts without modification are that they favor the wealthy, and that in the midst of an economic recovery with record deficits starting to pile up, we can’t tolerate them.
There is no question that these tax cuts have favored individuals with higher incomes. Historically, this always has been true of any tax cuts. Under our progressive income tax system, the only people required to pay higher marginal rates are those in the upper income brackets. Consequently, these high-end wage earners enjoy tax benefits that are disproportional to middle and low income taxpayers.
Proponents of extending the tax cuts, however, argue that they would be a welcome boost to an economy still struggling to emerge from the deepest downturn since the Great Depression. This argument is alluring and hard to ignore.
Strictly speaking, if extending the Bush tax cuts is viewed solely as a form of economic stimulus, the amount they would generate in tax savings could far exceed the nearly $800 billion President Obama allocated to re-energize the economy. Although the amount of tax savings from the Bush cuts is relatively easy to calculate, their actual impact as a form of economic stimulus is not as well quantified.
Examining Trickle Down
According to economist Arthur Laffer – namesake of the “Laffer Curve” – cutting taxes, especially among top income earners, will stimulate economic growth because more capital will be freely available to invest in the economy. The result of this additional capital investment will be more jobs at the middle and lower ends of the economic spectrum.
Intuitively, Laffer’s trickle down theory remains attractive. Unfortunately, the positives promoted by Laffer still are only anecdotal. To date, neither Laffer nor any of his supplicants has been able to provide quantitative evidence that trickle down actually works.
When it comes to stimulus, bigger is not necessarily better. Stimulus has to offer a lot of bang for the buck. In other words, for every dollar allocated – whether in direct spending or tax cuts – it should have the biggest possible effect on the economy.
In evaluating the impact of the extending the Bush tax cuts, the non-partisan Congressional Budget Office (CBO) calculated that their continuation would produce the equivalent of a 10- to 40-cent increase in the GDP for every dollar spent, or in this case not collected. Of the 11 different forms of stimulus examined by the CBO, continuing the Bush tax cuts rated at the bottom.
For example, the CBO concluded that the federal government could more effectively stimulate the economy by letting the tax cuts for high wage earners expire, then using the money to aid the states to extend unemployment benefits. Dollar-for-dollar, the CBO found that this measure would have about three times the impact on the economy as continuing the Bush tax cuts. This calculus was based, in part, on the accepted notion that lower and middle income individuals will spend this money faster because they will use it to purchase basic daily necessities.
Affected Number Is Too Small
Supporters of extending the tax cuts say that eliminating them will hurt small businesses. Statistically, however, less than 2 percent of tax returns associated with small-businesses report income in the top two income brackets – individuals earning more than $170,000 a year and families above the $210,000 threshold. Consequently, it does not appear that the middle road being offered up by the Obama administration will adversely affect small businesses.
When the Bush tax cuts were proposed in 2001, former Fed Chair Alan Greenspan was one the most vocal supporters. Greenspan argued that the tax cuts would pay for themselves by generating revenue and productivity among their recipients.
After seeing the tax cuts in action, Greenspan has done an about-face. In a recent appearance on NBC’s “Meet the Press,” Greenspan admitted that philosophically, he favored tax cuts “but not with borrowed money.”
In an era of exponentially increasing deficits, Greenspan concluded that additional tax cuts – even those proposed by the President – will add unneeded weight to an already crippling debt burden. Moreover, in the absence of the much needed revenue produced by doing away with the tax cuts, Greenspan feared that the government will be forced to borrow more. According to the former Fed Chair, this elevated level of government indebtedness will lead to higher interest rates that may put an unwelcome strain on private sector borrowing.
When the Bush tax cuts were implemented, the economy still was in the midst of an unprecedented expansion. With the economy on the rise, the impact of the tax cuts was offset by the record revenues being generated.
As the recession took hold and the economy shrank, so, too, did tax revenues. The cost of the bank bailouts combined with the stimulus packages further added to deficit and budget shortfall. By all accounts, the deficit will grow far worse before it gets better, especially if we continue the Bush tax cuts.
Even if the President seeks the middle populist ground by eliminating the tax cuts for the very wealthiest American wage earners, it will not change the basic math. The harsh reality is we can’t afford them. As much as it personally pains me, the Bush tax cuts must go.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
