Another View of the Bush Tax Cuts
Adam Looney at the Brookings Institution has a nice new paper on the Bush tax cuts. It can be summarized in this picture:
As Adam notes, the argument we are having is “whether to extend all of the tax cuts or merely to extend the vast majority.” Or, to put it a slightly different way: Do we want to “extend an extra $310,000 in tax relief to the wealthiest 120,000 taxpayers or …instead make a relatively small down payment toward fiscal responsibility?”
As Adam’s graph (and the Tax Policy Center analysis upon which it is based) shows, the highest 0.1% of earners (average income $8 million) would still benefit, to the tune of more than $61,000, even if the top rate is increased from today’s 35 percent to 39.6 percent, as President Obama prefers. How would they get a $60,000+ tax cut, relative to current law, if their rates are increased?
There are two big reasons. First, remember that Obama would extend the Bush tax cuts for income of $200,000 or less ($250,000 for joint filers). Thus, high-earners would still enjoy the benefits of lower rates on their first few hundred thousand dollars of income. They would also benefit from Obama’s proposal to tax dividends at 20 percent since that levy would rise to 39.6 percent (the same as the top rate on ordinary income) if the Bush tax cuts are allowed to expire.
Now, keep in mind that Obama’s plan to extend the 2001 and 2003 tax cuts for nearly all–as opposed to all—would still add trillions to the deficit over the next decade. When Adam says the Obama plan would make a “small down payment toward fiscal responsibility” he means it would make the deficit less bad—relative to current law—than extending the tax cuts for everyone, including the highest earners. Still, in today’s political environment, adding $3 trillion to the deficit over the next decade is better than adding $3.7 trillion.
My view (which Adam does not necessarily share) is that given budget realities, Obama is wrong to propose extending the Bush tax cuts indefinitely for as many people as he does. I'd lower the threshold even further–perhaps to $150,000–and continue the tax cuts for only a year or two. But in any event, do we really want to extend them for a handful of the very highest earners as well?
Instead of raising taxes, we need to cut spending.
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I agree that the 28% bracket should be allowed to go to 31%. Eventually, taxes for everyone need to go up to cover rising Medicaid and Medicare costs – however raising the Hospital Insurance Payroll tax now and putting the money in the Medicare Trust Fund will require raising income taxes even higher when the trust fund needs to be tapped. It would be better to enact a broad based value added tax paid by consumers (or a business income tax that is used to replace HI payroll taxes – and the gross income associated with paying them – giving everyone a roughly 1.45% gross wage cut across the board for the transition). An expanded business income tax would be paid by all employers, regardless of ownership type, and could also replace some portion of the income tax used to finance Medicaid (state and federal), general fund Medicare, health care reform and any conversion to single payer insurance. It could also fund education, TANF, workforce development and housing. Why not use a VAT? Because it should also be the vehicle for the distribution of certain tax benefits – specifically the health insurance tax exclusion (absent single payer) and the distribution of the Child Tax Credit (which would replace the mortgage interest deduction, the deduction for children, deductions against state taxes of all types (income, property, sales – Burman's idea), Supplemental Nutrition Assistance and Housing Assistance). The tax would also replace the Corporate Income Tax. The VAT would replace discretionary spending funded by the income tax, which would require a 13% rate. The BIT rate would be 33%, before credits and exclusions – although preserving the corporate welfare tax expenditures targeted at specific industries would require an even higher BIT rate – and it would necessitate a “hierarchy” of deductions, meaning that a firm must do the Child Tax Credit first, the health insurance exclusion second and then take the other credits only if they have liability left – although most firms will. As long as it is made clear that more targeted credits mean a higher rate overall, we can let the political process work its will – although businesses without an industry specific break may start opposing other breaks more vigorously.
When the government bond market collapses, forcing spending to be cut to match crashing tax revenues, this argument will be seen as an insignificant diversion from the real problem. It will be on a par with the forgotten list of complaints from the passengers on the Titanic before that fateful night.