Keep the Bush Tax Cuts for a Couple of Years, But Reshuffle the Dollars

By :: August 31st, 2010

It seems increasingly likely that Congress will extend most, if not all, of the Bush tax cuts for at least a year or two. As the economy shows growing signs of softening, lawmakers are less and less likely to take steps that will be seen as “raising taxes.” But there is a way Congress could maintain the magnitude of the Bush tax cuts while moving around some dollars to enhance their short-term economic benefit. The goal of this shift would be to focus tax cuts on those most likely to spend the money.

Here’s the problem: The Treasury Department figures that temporarily extending the 2001 and 2003 tax cuts would reduce federal revenues by roughly $200 billion in Fiscal 2011 and $260 billion in 2012. For technical reasons, those numbers may be off a bit, but you get the drift. Of that, about $75 billion would go to top-bracket taxpayers ($35 billion in 2011 and $40 billion in 2012). We know that higher income households are more likely to bank the cash than spend it. As a result, tax cuts for these high-earners will do relatively little to boost the economy in the short run.

So why not take that $75 billion and give it to those who are more likely to spend it—people with low- and moderate incomes. It would be simple to do. Congress could, for example, expand the Earned Income Credit. Or it could continue a scaled-back version of President Obama’s Making Work Pay (MWP) tax credit that is also due to expire at the end of the year.

My colleague Elaine Maag wrote recently about the benefits of extending a modified version of the MWP credit. But Elaine got me thinking: Instead of continuing the credit in addition to the Bush tax cuts, why not use it to replace some of the least stimulative provisions of the 2001 and 2003 tax laws. Btw, Making Work Pay also benefits some small businesses, including many self-employed people: Keep in mind the average amount of business income reported on individual tax returns is only about $40,000, far below the MWP threshhold.  
 
Extending Making Work Pay would cost about $60 billion-a-year. But by trimming it, and focusing its benefits on low- and moderate income households, Congress could fit these tax cuts into a two-year $75 billion bucket and still provide a modest boost to the economy.

There is a potential political benefit to moving these dollars around as well. Republicans could say they extended all of the Bush tax cuts (at least in magnitude, if not in specifics). And Democrats could take credit for retargeting those upper-bracket dollars.  

Economists generally agree that Washington is in a serious fiscal jam. It needs to boost an economy that may again be running out of steam. But given long-term deficit challenges, it also must conserve precious federal dollars. In this environment, it is imperative that policymakers get the biggest bang for the every stimulus buck.

So instead of squabbling over whether or not to continue $75 billion in tax cuts, Congress should simply retarget the dollars to those most likely to spend them.

15Comments

  1. Anonymous  ::  8:10 pm on August 31st, 2010:

    The whole point of the argument is to provoke an ideological fight and thus turn this into an election issue. If doing it non-controversially was the goal, a budget with reconciliation instructions would have been passed and the preservation of the cuts for the middle and lower classes could have been done with a simple majority in both houses.
    Nope, this is about pre-election drama, which I deeply resent since this drama could cost me $20-$40 a week in tax benefits. It does not sound like much until you multiply it by 4.3 for the monthly cost of between $85 – $170 a month. That starts adding up for households that can least afford it.
    I appreciate your efforts at finding a compromise, however that won't stop Pelosi and Reid from playing chicken with my family budget.

  2. Anonymous  ::  8:15 pm on August 31st, 2010:

    This also ignores the fact that people who fund the Republican side also want their ideological point made to rally their base as well. The Koch brothers want this debate as much as Pelosi and Reid, and their client members of Congress and the Senate have to put on a good show to stay in their good graces.

  3. Anonymous  ::  3:36 pm on September 1st, 2010:

    The fundamental problem with many intellectuals and pundits is that they seem to think that lowering and raising taxes is a static zero sum game, that taxes have no impact on individuals investment decisions and behavior. Their arithmetic is simple you extend the Bush tax cuts and the Treasury looses $200 billion in Fiscal 2011 and $260 billion in Fiscal 2012.
    It has never been the case since an economy is an aggregate and is dynamic, not static. For instance the Reagan Tax cuts and the Bush tax cuts contrary to the common myth increased revenue to the Treasure after they were implemented i.e. the overall revenue grew because the underlying economy got a boost and grew and therefore there was more overall to tax.
    Raising taxes will not as the proponents argue mean that the budget deficit will be lowered by stopping the Bush tax cuts $200 billion in Fiscal 2011 and $260 billion in Fiscal 2012. It could even be a wash. Higher taxes might mean lower investments and less spending and could cause capital to flee the US. It's what happened in my my birth country Sweden, a prime example of of how increased taxes in fact gave rise to lowered Treasury income as well as massive capital flight i.e. the net effect was negative. Sweden during the 70-80s is the perfect empiric example of the Laffer Curve effect.
    No this debate is not about technicalities its purely ideological. Do you think that politicians and bureaucrats are better at allocating resources by redistributing taxes from the productive sector to the non productive sector (private to public sector) and by choosing winners and losers in the market place (GM, Chrysler vs Ford) or are individual and entrepreneurs better at allocating their own resources so that everybody get a maximized share?
    For those that study tax policy take a deep and hard look what happened in Sweden 1968-1993 and the massive reforms that took place after 1990, especially during Sweden's banking crisis 92-93.
    For me as born in Sweden living in the US I'm like Alice in Wonderland, shaking my head that US intellectuals and social scientists argue policies that took Sweden to the brink of ruin instead of arguing the polices that saved Sweden and Northern Europe, and made it one of the strongest economies in old EU while the rest of old EU is crumbling because of the same old bad policies.

  4. Anonymous  ::  4:20 pm on September 2nd, 2010:

    The analysis of revenue shows that the Bush and Reagan tax cuts actually reduced revenue, although nominal revenue did increase because of inflation. In absence of these cuts, revenue would have increased more.
    The purpose of extreme tax rates on the wealthy, which are not up for debate, are to stop them from claiming higher compensation for themselves because doing so would only go to the tax authorities. In other words, fortunes do not get made yet individuals still go to work every day in executive jobs – meanwhile the rank and file worker is better off.
    When the Reagan cuts happenned, executives had an incentive to cut worker salaries and go to their boards and demand higher salaries for themselves for increasing profitability. They also offshored work for this reason. If tax rates had been higher, they would have had no reason to do this. While one can make a utilitarian argument that this is good for the overall economy, the results of this hollowing out of the middle class led it to use debt to replace lost income and our current economic crisis is the result.
    There are now two options to restore the middle class. One is to greatly increase taxes on the wealthy – back to pre 1980 levels, so that CEOs just don't have any incentive to ask for more money or stock options – or to encourage employee and union ownership by repealing diversification requirements on Taft Hartley pension funds – as well as reversing requirements that pension funds be fully funded and not funded to simply meet payouts plus a reserve. Another avenue is for Social Security personal accounts invested in ESOPs and employer stock funds rather than Wall Street. In time, employees would control most companies and would reign in CEO pay.

  5. Anonymous  ::  6:01 pm on September 2nd, 2010:

    There is a strange disconnect between the amount of taxes paid by “the rich”, in the US $ 200,000 and in Sweden $ 75,000, and the taxes paid by an individual. As a collective in the US the rich 3 % of the population pay 52 % of the taxes. Their tax burden rose during the Bush years by 25 % i.e. from 42 % to 52 %. The tax burden of those making less than $ 200, 00 o fell dramatically. So as a matter of fact George W. Bush tax cuts caused the “rich” to pay more in taxes.
    Thank you for the clarification of the tax situation but my main contention holds, the Bush and Reagan tax cuts only marginally lowered revenue but only if inflation was accounted for i.e. he dynamic effects of the tax cuts made up for the lowered revenue because of the tax cuts. The Laffer Effect is so to speak empirically proven by what you are saying.
    For me as a pragmatic and utilitarian I don’t agree that the purpose of taxes is to punish certain groups of people that the political majority finds offensive for ideological reasons. For me this is the worst problem with pure majoritarian democracy, the majority imposing pain on a minority that has no political power. For me taxes main purpose is to raise revenue in an as effective way as possible without causing unintended consequences in investment and labor behavior.
    The “rich” do not claim higher compensation for themselves. Business owners make money from satisfying customer demand, its called the free market.
    CEOs are a special class of people the are basically bureaucrats (managers) without any stake in the company, they take no risks.
    Unfortunately they have been able to rob shareholders. But robbing shareholders is not the same as robbing workers or the IRS. CEO compensation is between the shareholders and the CEO, not up for political consideration.
    Further you cannot base a tax system on 1,500 Fortune 500 CEO, its in fact absurd. The average salary of a non Fortune 500 CEO has risen very slowly and in accordance with the overall economy.
    Basing a tax system on 1,500 will cause tremendous unintended consequences, it will kill future small business owners and solidify the wealth structure in the US. In Sweden we saw this. Small business owners were eradicated from 1950-2000 (top marginal taxation peaked at 102 %), all entrepreneurs fled Sweden in the 70-80s. The CEOs and ultra rich got special tax dispensations and as a results Sweden has the highest wealth GINI inequality in the world but at the same time the lowest income GINI inequality.
    So the mantra “tax the “rich”” means in fact “kill the future small business owners and conserve the power structure that is”.

  6. Anonymous  ::  7:23 pm on September 2nd, 2010:

    But the raising the income, inheritance and dividend taxes on those 1,500 is exactly what we are talking about, as well as others in their income class.
    It is nonsense to say that tax increases kill small business, since when a small business hires an employee, they deduct the cost of that employee from their taxes. That would not be true if we shifted part of the tax burdent to a VAT, but whether that would be a job killer or not depends on the details.
    If your hypothesis were true, we would have had a recession in 1995 when Clinton raised taxes on the rich. Instead, we had expansion. The tech bubble resulted when Clinton got caught with his pants down and lowered the capital gains tax rate in order to make nice with the GOP. That mistake started the problems of the 2000s, leading to the overreaction of the Fed and the balooning of debt.
    As for the lowering of wages, it is documented that CEOs demand higher wages when they prove savings and that savings is usually inclusive of a tough labor deal. Time and again there are reports of wage cutbacks and matching CEO raises.
    What we don't hear about is the connection between bankruptcy reform and the construction of models that said housing could not lose value. If cramdown provisions on mortgage debt had not been removed from the bankruptcy code, I doubt whether those models could have been constructed – since such actions would have had to have been factored into the models. That would have led to more dilligence in making loans and the housing market would have never inflated.

  7. Anonymous  ::  11:20 pm on September 5th, 2010:

    One of the problem with the tax code is the ability to game the system that give some taxpayer the ability to pay the lower tax rate while others pay more. CEO can do this simply asking the Board of Directors Compensation Committee(usually handpicked) to utilize the company to pay their taxes for them. At this point the salary and perks is 500:1 in comparison to the wages of the average workers within the company.
    You need to consider that only 53% of the tax payers are paying their taxes while 47% are not.

  8. Anonymous  ::  5:22 pm on September 7th, 2010:

    All the more reason for a VAT, so that everyone pays something in income tax. Actually, the 47% figure is only for income tax – the vast majority of these taxing units still pay FICA and while some may have their payments mitigated by the EITC, most don't. The tax benefits these families do get are a subsidy to employers, since without these subsidies the demand for higher wages may be greater. Then again, it may not be, since if the employers in that industry have monopsony power over wages (meaning the labor market is not free – a common problem in much of the American south), taking away these benefits simply leaves poor people making less and working just as hard. Until and unless the funding of the enforcement of wage and hour laws is drastically increased and right to work laws are overturned by federal legislation, wage subsidies are not only necessary but should be increased.

  9. Anonymous  ::  2:20 pm on September 9th, 2010:

    Let the tax cuts for the wealthy expire now. That's a start. Then cut taxes on the middle-class, cut the deficit and pay for both with increased taxes on the wealthy. All this could be done if the wealthy were just taxed at the same rates as poor and middle-class workers.
    Warren Buffett, a billionaire, recently paid a total tax rate (combined federal, state & local) of 0.2% of his income and investment gains. A millionaire couple can easily pay only 4% of their annual investment gains in total taxes. A typical single person earning a minimum wage pays taxes amounting to 22% of her wages, a rate more than 100-fold higher than Mr. Buffett’s. From http://fairsharetaxes.org
    The top 1% in the US have gone from owning 22% to 40% of the nation's wealth in the last thirty years. This is largely due to the tax cuts for the wealthy investor class, started under Reagan 30 years ago. They were supposed to encourage investment and strengthen the economy. Instead, average GDP growth during 1951-86, when the top federal income tax rates ranged form 50-92%, average annual GDP growth was 3.6%. Since then, when the top tax rates were cut and ranged from 35-39%, average annual GDP growth dropped by one-quarter to 2.7%. Favored tax treatment of the rich doesn’t help the economy In fact it hurts it…..
    The favored tax treatment for investments and the wealth concentration that resulted has lead to the demand for investments exceeding the supply of worthy investments … Investment bubbles … our last two recessions … and then all but the wealthiest are at risk of losing their jobs, their homes, their opportunity to educate their kids, and their retirement savings.
    For more, including a proposal for comprehensive tax-reform that would cut taxes on the middle class, cut the deficit and strengthen the economy, see http://fairsharetaxes.org

  10. Toi Bickett  ::  2:39 pm on May 10th, 2011:

    That is my first time visiting your blog. I do envy you since you seem to get a lot more feedback then I do

  11. Fox News Adds Nothing But Falsehoods To Deficit Debate | Hateriotic.org  ::  4:08 pm on November 14th, 2012:

    […] The Treasury Department figures that temporarily extending the 2001 and 2003 tax cuts would reduce federal revenues by roughly $ 200 billion in Fiscal 2011 and $ 260 billion in 2012. For technical reasons, those numbers may be off a bit, but you get the drift. Of that, about $ 75 billion would go to top-bracket taxpayers ($ 35 billion in 2011 and $ 40 billion in 2012). We know that higher income households are more likely to bank the cash than spend it. As a result, tax cuts for these high-earners will do relatively little to boost the economy in the short run. [Tax Policy Center, 8/31/10] […]

  12. Fox Pushes Six Tax Myths Ahead Of Spending Negotiations | Hateriotic.org  ::  3:52 pm on November 19th, 2012:

    […] The Treasury Department figures that temporarily extending the 2001 and 2003 tax cuts would reduce federal revenues by roughly $ 200 billion in Fiscal 2011 and $ 260 billion in 2012. For technical reasons, those numbers may be off a bit, but you get the drift. Of that, about $ 75 billion would go to top-bracket taxpayers ($ 35 billion in 2011 and $ 40 billion in 2012). We know that higher income households are more likely to bank the cash than spend it. As a result, tax cuts for these high-earners will do relatively little to boost the economy in the short run. [Tax Policy Center, 8/31/10] […]

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  15. Tax Language for the Totalitarian State  ::  10:27 pm on March 7th, 2015:

    […] stimulated the economy. If it didn’t it was only because we didn’t spend enough. Hence, the poor ought to receive all the tax cuts and the rich […]