Tax Cuts: Extend or Eliminate?

Tax Cuts: Extend or Eliminate?

Upper-income earners are likely to be hit with new taxes

Before the year is out, the expiring personal income tax cuts of 2001 and 2003 will likely be extended — except for those with high incomes.

President Obama set the terms in his presidential campaign: no tax increases except for couples filing returns with taxable incomes of more than $250,000, and singles above $200,000. For couples with incomes above about $375,000 a year, the top tax rate would go from 35 percent to 39.6 percent, as it was back in 2000.

Republicans want all the Bush tax cuts made permanent, even for the wealthiest Americans. But they will have to think twice before blocking legislation that excludes the wealthiest from the tax cut extension. For one thing, the Treasury stands to collect close to $1 trillion in tax revenues over the coming decade if upper-income Americans (with incomes above $200,000) are excluded from the tax cut — an important chunk of change in these times of towering deficits. Second, Republicans risk invoking the ire of most taxpayers if they block an extension of the tax cuts to protest higher taxes on upper income earners. 

If the Democrats and Republicans were really concerned about the long-term fiscal problems the government faces and the need for long-overdue tax reform, none of the cuts would be made permanent, even for middle-income taxpayers. Whether Congress has the courage to admit it, any measure it passes to make the Bush tax cuts "permanent" by necessity will be only a temporary action. Putting the federal budget on a sustainable path in all likelihood will eventually mean raising taxes, even on the middle class. Obama is going to have to accept that when the time comes, and he will have a good excuse: The budget outlook after two brutal years of recession is far more dire than when he was campaigning.

House majority leader Steny H. Hoyer of Maryland pretty much said that last month in a remarkable speech about the need for a broad long-term budget agreement and what it might involve.

"As the House and Senate debate what to do with the expiring Bush tax cuts in the coming weeks, we need to have a serious discussion about their implications for our fiscal outlook, including whether we can afford to permanently extend them before we have a real plan for long-term deficit reduction," Hoyer said.

"Unfortunately, we can blame our long-term deficit on policies that are almost universally popular," he said. "We're lying to ourselves and our children if we say we can maintain our current levels of entitlement spending, defense spending and taxation without bankrupting our country."

Clearly, the majority leader was cautioning that even middle-income taxpayers might have to accept higher taxes as part of a comprehensive budget deal.

As for now, Hoyer cautioned, "the House will not extend the tax cuts benefitting taxpayers of incomes above $250,000 despite some suggestions in the Senate that they be extended along with all other Bush tax cuts."

Politically, neither Obama nor congressional Democrats are about to back off letting those tax cuts for the rich expire.  And after dithering for a year, it's time for Senate Democrats to renew the estate tax with the 2009 terms — an effective exemption of $3.5 million per person and a tax rate of 45 percent. 

With the budget squeeze, there's no reason to forego that estate tax revenue, in the range of $30 billion to $50 billion a year, according to CBO estimates. 

Many economists are urging lawmakers to make it clear that the tax cut extension will only be temporary, for the good of fiscal policy. "I think that we need the support for the economy in the short term that would come from keeping all of the current tax rates," Harvard University economist Martin S. Feldstein said in an interview. "But the extension should be limited to two years because of fiscal concerns. I think that would also boost demand by improving confidence."

Economist William G. Gale, a tax expert at the Brookings Institution, would also extend all the cuts but only for one year. “How can anyone propose making them permanent with a straight face, given all the talk about fiscal problems?" Gale asked in an interview. "With the president's fiscal commission reporting on Dec. 1, I would not want a big tax change on Jan. 1, and I would not want a tax increase with a relatively weak economy."

Mark Thoma of the University of Oregon, whose liberal "Economist's View" blog is widely read, sees the expiring tax cuts as an opportunity to give the economy a boost. He would let them expire for upper-income taxpayers and use the revenue not to trim deficits, but to cut taxes even further temporarily for other taxpayers.

"I don't think raising taxes while the economy is still recovering is a good idea," Thoma said. "But that doesn't mean we can't use the expiration of the taxes as an opportunity to shift the burden more toward higher income households," and help "low- and middle-income households struggling with the weak economy and job market."