Extend the Bush Tax Cuts? It’s the Wrong Question

By :: August 3rd, 2010

Washington is about to spend months trying to answer the wrong question. Instead of reprising their partisan, tiresome, and largely unproductive argument about what to do with the Bush tax cuts, President Obama and Congress ought to be asking a very different question: How do we build a tax system capable of generating the revenues we need to fund the government we want in the most efficient and fair way possible?

The debate over the Bush tax cut will get us nowhere. Already, Republicans are accusing Democrats of wanting to raise everyone’s taxes. Democrats accuse Republicans of pandering to their rich pals. They are like eight-year olds: “Did not. Did too. Did not.”

The pols are trapped in an argument about whether the distribution of taxes in 2000 was correct, or whether the distribution in 2010 is right, as if there are no possible alternatives. They haggle over whether it is best to extend the current tax breaks for everyone, or only for those making $250,000 or less as Obama prefers, as if there are no other options. And hardly anyone mentions the nearly $3 trillion increase in the national debt we’ll face over the next decade even if we extend the tax cuts only for those making less than $250,000.

Just think how much more productive it would be if we reframed the entire debate. I was asked about this today on the syndicated NPR show Here and Now, and it is a fair question. Why have we allowed ourselves to remain trapped by a decision made nearly a decade ago? Some pols would have us believe the 2001 tax cuts were the Ten Commandments, fixed and immutable for all time. But why not think outside this particularly small box?  What sort of government do we want? And how should we pay for it? This question inevitably leads to a couple of others that can help us focus even more:

*Should the income tax continue to be the foundation of our revenue system? If so, do we want to raise rates while protecting hundreds of billions of dollars in special interest tax subsidies. Or should we reprise the 1986 Tax Reform Act, where we broadened the tax base by eliminating many special provisions and lowered overall rates. It seems like a good idea to me, but let’s debate it.

*Is the income tax fixable at all, or is it so broken that we’ll need to replace it, or supplement it, with a Value Added Tax or some other consumption tax? Such a change would have profound implications, not only for the budget, but for spending, savings, and investment. And it could create a very new set of winners and losers than under the current tax system.

*What is the role of Social Security and Medicare taxes in a fair and efficient revenue system? With almost no discussion, this year’s health law fundamentally changed the nature of the Medicare tax by imposing it on investment income, rather than just on wages (starting in 2013). Perhaps we want to talk about this one some more.

There is plenty of blame to go around for Washington’s failure to have this discussion. I place much of it in the lap of Obama, however, who has never shown the same enthusiasm for reforming taxes as he has for remaking health care, education, and the financial markets. Perhaps his deficit reduction commission will take fundamental tax reform seriously, though I’m not holding my breath. It is as if the political wizards inside the White House have counseled Obama to avoid the issue at all costs, just as President Bush’s advisers urged him to walk away from tax reform.

Maybe they are right about the politics. Who knows? But I do know this: Until Obama and Congress ask the right question, there isn’t much chance they will come upon the correct answer.

14Comments

  1. Anonymous  ::  9:03 pm on August 3rd, 2010:

    The Fiscal Commission is actually addressing these questions, while ignoring the divisive question of the tax cuts on the wealthy.
    This debate is being held for electoral reasons, since it could have been avoided with reconciliation instructions in a budget resolution to preserve the tax cuts that the President wanted to preserve, even temporarily. The Reconcilation would have been quietly passed – or loudly passed – without any chance that the Republicans could block it. What we see now is a high risk strategy to tempt the Republicans into blocking tax cuts for the poor and middle class in the interim – largely for political theater at election time. This may serve the GOP in shoring up their base or it may erode it.
    It is high risk on both sides and I would rather the Democratic leadership not gamble on this issue, since it has consequences for those families that can least afford it.

  2. Anonymous  ::  11:32 pm on August 3rd, 2010:

    Oh, and if you really want to spark debate, score the tax plan I sent them (and copied you on).

  3. Anonymous  ::  3:45 am on August 4th, 2010:

    The idea that the distribution of the tax burden can never become less progressive is very much at odds with the need for more revenue. Marginal rates on high earners and investment income (including state income taxes) are probably within 20% of their Laffer peak, beyond which further increases will reduce revenue. The maximum amount of revenue that can be gained from these sources is much less than what's needed. Taxes will need to increase on the middle class, and that means decreased progressivity.
    The only way that Democrats can finesse this dilemma is to enact a VAT. Then they can still claim that the income tax did not become less progressive.

  4. Anonymous  ::  9:16 pm on August 4th, 2010:

    20% of income or 20 percent of total? A 20% increase is still 55% of income. We have a long way to go.
    I agree with doing a VAT, by the way – as well as an expanded business income tax (all businesses, all value added) with deductions for tax expenditures.

  5. Anonymous  ::  9:26 pm on August 4th, 2010:

    20% of gross. Current top rates are 45% or more (35% for Fed AMT up to $450k or so plus 10% for California). ObamaCare adds several percent to this. I figure 65% is where people will seriously curtail making and reporting taxable income.
    My point is that you can compute 20% of gross income for the top 2%ers and it won't come close to solving the fiscal gap. For the rest of the solution, only regressive options are available.

  6. Anonymous  ::  10:06 pm on August 4th, 2010:

    VAT deserves analytical consideration, not knee-jerk opposition by those fearing demagoguery on taxes.
    A REVENUE-NEUTRAL VAT replacement for Corporate Income Tax would be stimulative — both for U.S. business and for U.S. employment. Later, after streamlining budget expenses, if taxes need to be raised, the VAT would be in place.
    Gone would be the double-taxation of dividends.
 Gone would be the competitive disadvantage to U.S. in world trade, as foreign goods would carry an equal (government) burden as domestic production.
Gone would be the incentive for U.S. multi-nationals to use transfer pricing to shift profits to lower-taxed countries.
    And, in the short-term there would be a stimulus effect…off-budget…as consumers speed purchases in advance of tax implementation.
    CBO needs to run the numbers. Why not?

  7. Anonymous  ::  12:46 am on August 5th, 2010:

    VATs are fine in concept. The likely congressional execution gives me night sweats. Think about how Congress manages the income tax code. The potential for meddling (or tax expenditures as we like to call them nowadays) is orders of magnitude greater with a VAT.
    I'd have no problem with one if it would stay clean. Since I really doubt that could happen, the prospect makes me very nervous.

  8. Anonymous  ::  1:35 pm on August 5th, 2010:

    Yes, Congress will deliberate about preferentially-taxed categories, and that should be resisted, as it would be “the camel's nose under the tent.” A clean VAT with no exceptions is best. As David Brinkley wryly observed in 1991 when Jerry Brown (in his presidential campaign) called for a VAT to replace the corporate income tax, what would Congressmen do without lobbyists to take them to lunch to press for tax loopholes?
    Gale and Harris (Brookings, “A Value Added Tax for the United States: Part of the Solution,” July 2010) cite that in 2007, 17 of 29 OECD countries with a VAT zero-rated at least one preferential category. But, Toder and Rosenberg (Brookings, “Effects of Imposing a VAT to Replace Payroll or Corporate Taxes, 03/18/10) suggest that instead of preferential rating that a cash payment be made to everyone to cover the burden on lower incomes.
    For links to the above cited papers, go to VAT-US.com

  9. Anonymous  ::  11:42 am on August 6th, 2010:

    But it won't be resisted. The role of Congress is to give stuff to constituencies. One need only look at the income tax to recognize this. A VAT will be no different. As a consequence, it is entirely unclear that the potential for lower levels of distortion inherent in a VAT will be realized once Congress is done with it. Personally, I would only support a VAT if it came with some Constitutional assurance to prevent future meddling. Since that seems pretty much impossible to me, I'll take a preference-riddled income tax over a preference-riddled VAT. In the latter, Congress will convince itself it should determine our preference for items by determining their relative tax rates.

  10. Anonymous  ::  4:40 pm on August 6th, 2010:

    A VAT and an expanded business income tax (all entities, all value added – including wages) could be used to replace (or expand) the current corporate income tax, low rate personal income taxes, non-OASI payroll taxes (including Hospital insurance) and the lower portion of higher rates. Some deductions, such as the Child Tax Credit, could be taken against the Business Income Tax and the remaining personal income tax would be limited to the top 10% of income earners and would be relatively deduction free.

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