President Barack Obama’s new tax deal with Republicans avoids tax hikes, but the loser is the deficit, swollen with transfer programs that would not add to economic growth.
Nevertheless, the compromise is better than allowing taxes to rise on Jan. 1, potentially sending the economy into another recession, according to White House economic director Larry Summers.
The new law would keep current tax rates on income and capital for two years, reduce the estate tax below the draconian levels that would otherwise apply in 2011, and keep in place most existing tax credits for individuals and businesses.
In return, the Republicans have agreed to extend unemployment insurance benefits for the long-term unemployed — over 26 weeks — by 13 months, without offsetting cuts in federal spending. Cost: $56 billion.
Obama’s Making Work Pay refundable tax credit ($400 for workers earning under $75,000) would be replaced by a cut in workers’ payroll taxes, from 6.2 percent to 4.2 percent on the first $106,800 of annual earnings. Cost: about $120 billion.
The late Milton Friedman won a Nobel prize for showing that consumers were more likely to save rather than spend temporary tax cuts, such as the reduction in the payroll tax.
Hence, neither Obama’s Making Work Pay credit nor President George W. Bush’s $120 billion in stimulus checks mailed out in May 2008 rescued the economy.
Obama complained about the cost of extending upper-income tax rates, $79 billion over two years, but this is dwarfed by the payroll tax cuts and unemployment insurance extensions, $176 billion for just over a year.
That’s why Vice President Joe Biden distributed charts to House Democrats on Wednesday showing that “what we got” was twice the size of “what they got.”
The White House explains that “a working family with three children making $20,000 will continue to receive a tax cut of more than $2,000 as a result of the Earned Income Tax Credit and Child Tax Credit expansions.”
But this family pays no income taxes, so it cannot receive tax cuts. Its payroll taxes amount to $1,240, and would decline to $840 in 2011 under the new law. If the administration wants to increase subsidies to low-income Americans, it should do so transparently, and pay for them.
Obama explained on Tuesday that extending present tax rates for those who make over $250,000 in gross income is a waste of revenue, yielding no economic benefit and coming at the expense of government services for veterans and low-income people.
In Obama’s world, those who earn over $250,000 per year don’t use their money for the benefit of others unless they give it away, like Facebook CEO Mark Zuckerberg.
So the president assumes that the government can tax the most productive people in the economy, those with the highest incomes, without negative consequences for the others, and that the actions of the top income groups don’t affect the well-being of people making less.
Yet top income filers buy goods and services, own or manage businesses that employ other Americans, and have investments that fund businesses that create jobs.
Treasury data show that 48 percent of income on individual tax returns goes to unincorporated business owners making more than $250,000 a year. If these businesses’ taxes rise by 5 percentage points, some close or curtail expansion plans.
Economic studies clearly show that tax cuts lead to more economic growth than do spending increases.
Just one example — Christina Romer, who headed Obama’s Council of Economic Advisers, in a 2010 paper in the American Economic Review on postwar tax policy, found that $1 of lower taxes boosted national income over the next three years by $3.
The bipartisan tax deal is expensive, but it’s better than letting taxes go up in January. Let’s hope the 112th Congress can cut spending to pay for it.
Examiner columnist Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute.