Let the Bush Tax Cuts on the Wealthy Expire

by Michael Ettlinger

This article was published by the Center for American Progress.

President Barack Obama made clear during his campaign for the presidency that he intended to let the Bush tax cuts for the wealthy expire on schedule at the end of 2010. The administration’s long-term budget outline counts on this happening. It is key to getting the federal budget deficit under control. Congress, in the coming year, should make it happen.

The curious may want to know why the Bush tax cuts are set to expire in the first place. After all, if then-President George W. Bush and Congress thought they were a good idea when they passed them in the early 2000s, why make them temporary?

The answer is that President Bush and a complicit Congress didn’t want to show the magnitude of the deficits that would result from their tax cuts. To hide those deficits as they were pushing them through they used a variety of accounting tricks. One of those tricks was attaching expiration dates so that, on paper, there wouldn’t be any long-term costs. This made the long-term deficit picture look fairly rosy on paper even as it doomed Bush’s successor and the current Congress to cleaning up the mess.

The mess handed to the current president and Congress couldn’t be better designed to make their lives miserable. If they take no legislative action and let the cuts expire there will be a nice juicy tax increase at the end of 2010. Taxes on the wealthy will go up the most since they got the biggest tax cuts under President Bush. But the Bush tax cuts also handed out morsels up and down the income spectrum.

Policymakers are damned if they do and damned if they don’t. If they let the tax cuts expire they’ll be blamed for raising taxes. If they extend the tax cuts, the deficit picture suddenly looks worse because, on paper, we’ve been counting on the money from the tax cuts expiring to keep the deficit down. The choice of either looking like tax raisers or deficit raisers is no fun at all.

President Obama during the campaign last year offered a middle ground. He proposed extending the tax cuts on those with less than $250,000 of income and letting most of them expire on those with income greater than that. This way he keeps taxes constant on the middle class, raises them on the well-to-do, and the deficit picture doesn’t look as bad as if all the tax cuts were extended.

Decision time is fast approaching, with the tax cuts expiring at the end of 2010. Those who would receive a tax hike will put up a fight. They’ll throw up the usual supply-side smokescreen about taxing investors, hurting small business, and the rest. But given thefailure of the Bush tax cuts to deliver the strong economy that was promised those arguments aren’t likely to carry the day.

Another argument we’ll hear is that $250,000 per year isn’t “rich.” That’s fair enough—in some places it isn’t. But it’s still doing pretty well. For the nation, only about 2 percent of households have income over that level. Even New Jersey, the state with the highest median income for the relatively prosperous demographic of families of four, only clocks in at $103,000.

And consider how the tax increase will work. One of the sensible features of the tax code is that it generally operates on marginal income. What that means in this case is that just because someone has $250,001 in income doesn’t mean they suddenly pay more taxes on their entire $250,001. They essentially only pay more in taxes on the $1 that exceeds $250,000.

Thus, it’s not really the poor folks making $250,001 who will be hit hardest by this but those who make well more than that. Asking a bit more from people making over $250,000, even if in some places they don’t consider that to be “rich,” isn’t asking for a huge sacrifice. Nowhere is it written that when additional taxes are necessary the richest of the rich should pay all of them.

Another argument against allowing the high-end Bush tax cuts to expire will be that we shouldn’t raise taxes during a recession. Of course, by the beginning of 2011 one would hope we won’t be in a recession anymore. Even if we aren’t, however, we’re likely to continue to have high rates of joblessness—so the argument will have resonance. In fact, it’s the best argument the opposition has. After all, “don’t raise taxes during a recession” is a bit of an adage with economists. It makes sense. During a recession it’s better to put money in people’s pockets—without worrying too much about the government’s budget deficits—to encourage spending in the economy so businesses have customers, which encourages the businesses to start hiring and making investments. Raising taxes goes in the opposite direction. During the campaign then-candidate Obama hedged on whether the tax increases would be appropriate if a recession was still going on.

The adage of “don’t raise taxes during a recession” isn’t a crazy adage, but like most adages it’s an oversimplification. For one thing, if that’s the rule, state governments with their balanced-budget requirements that limit their ability to deficit spend should be exempt—their spending is valuable to the economy and if they need to tax more to keep it up, that may be better for the economy than keeping their taxes the same.

Even for the federal government, which can deficit spend, it’s important to look at all the options. While lower taxes during a recession can help the economy rebound, lower taxes for the wealthy are about the worst way to do it. Lower taxes for middle- and low-income people is a much better way to help the economy because middle- and low-income families are much more likely to spend their money than the wealthy. And it’s spending that we need to create the demand that will encourage businesses to hire and invest.

If we decide we don’t want to raise taxes in a recession we should instead move the tax cuts around a bit. That is, let the tax cuts on those making over $250,000 expire and use the money to give tax cuts to people who could use the help and—more importantly for the economy—are more likely to spend the money they receive. Giving a temporary tax break, or tax rebate, to middle- and low- income families would be much better for most people and much better for everyone because they would help get the economy back on track far more than the Bush tax cuts.

There’s also another option that would be better for the economy. We could let the Bush tax cuts on those making over $250,000 expire and use the funds for other job creation measures that are likely to be more effective than tax cuts.

We could, for example, use them to help state and local governments avoid laying off teachers, firefighters, and other public service workers because of the enormous shortfalls they’re facing. There are a host of ideas for how the money could be spent better for job creation that are better than leaving the Bush tax cuts alone. With these ideas, we aren’t dependent on how the recipients of tax cuts spend their largess for the economic boost we hope for. With these ideas, the funding goes directly into the economy in the way we most need it.

That is, of course, our ultimate goal—a healthy economy. We ought to do what it takes, on both the tax and spending side, to make that happen. And that might in fact include raising taxes on some during a recession.

Michael Ettlinger is the Vice President for Economic Policy at American Progress.

For more on this topic see:

• Job Creation in a Recession: The Basics by Michael Ettlinger
• Take a Walk on the Supply Side by Michael Ettlinger and John S. Irons