More on the Tax Deal

First, the comic relief. From the Times:

“Senator Jim DeMint, Republican of South Carolina, said that he still wanted the Bush-era rates extended permanently and that the cost of the package was worrisome.”

I got some valid criticisms for my last post on the tax cut deal. In particular, that post may make it seem as if my criticism of President Obama has to do with his negotiating ability. But if Obama really wanted the outcome he ended up with, then he is a master negotiator; where I really differ from him, then, would be in what policy should be.

Obama has said for years that he wants to preserve the tax cuts for the “middle class,” but not for the rich. For the purposes of this post, “middle class” means a household with less than $250,000 in annual income. Of course, this is ridiculous, since $250,000 lands you easily in the top five percent of the population by income, according to Census figures. Why Obama chose to draw the line to separate the extremely rich from the very rich is something I’ve never understood. And besides, households above that line still benefit from the tax cuts as well, because they pay less taxes on their incomes up to $250,000, just like everyone else. In dollar terms, someone making $500,000 benefits just as much as someone making $250,000, and much more than someone making $50,000.

More recently, he has also said that he wants to stimulate the economy to help with the recovery. So you could say he got everything he wanted, except that he had to agree to tax cuts for the rich in order to get it.

Well, I want a pony. I want to repeal all the Bush tax cuts, and eliminate the mortgage interest deduction, and eliminate the income cap on payroll taxes, and eliminate preferential rates for dividends and capital gains, and tax carbon emissions, and cut the defense budget (and secure lasting peace in the Middle East). I want to use some of those increased revenues to reduce the long-term deficit, some to provide block aid to state and local governments, some to extend unemployment benefits permanently, and the rest to fund a refundable tax credit for poor people that will basically ensure a minimum standard of living for everyone. But that’s not going to happen. You have to choose among the options you have.

In effect, saying that tax cut extensions for the rich are a reasonable price to pay to save tax cut extensions for the middle class is the same as saying that the Bush tax cuts were, on balance, a good policy. Or that securing one last extension of unemployment benefits (since they expire before the rest of the tax cuts, there’s no chance they’ll be extended again by a Republican-controlled House) was enough to make it good policy.

There is always the “in the middle of a recession” defense. But again, you don’t get exactly what you want in politics. You can’t say the deal was a good deal because you can fix all the bad things about it in two years. I also want stimulus now and higher tax revenues later. But that’s not a credible option. If you think the tax cuts were bad policy, your chances of fixing that bad policy are much worse in two years than they are now. The administration’s best card would have been a threat to veto any bill that contained an extension of the tax cuts for the rich. The House is going to pass an across-the-board permanent extension in 2012. Are the Democrats going to block it in the Senate in an election year? Is Obama going to veto it in 2012? (And even if he leaves it for a lame-duck session, he’s going to have to make a commitment during the campaign.)

This was the best chance to kill the tax cuts once and for all. Yes, it would have been worse in the short run for the economy. But this is a huge price to pay for a modest stimulus made up entirely out of tax cuts (largely tax cuts for the rich). Instead, we are stuck with a huge reduction in the tax burden of the rich and a small reduction in the tax burden of the middle class–which, on balance, helps the rich and hurts the middle class–forever. If we can infer people’s preferences from their behavior, then the logical inference is that Obama thinks the Bush tax cuts, taken as a whole, are good policy.

Finally, are the “middle-class” tax cuts really worth fighting for? Or, to put it another way, why does Obama care about them so much? Contrary to the beliefs of the Tea Party, money doesn’t just get eaten by a big monster when it goes to the IRS. It gets spent on stuff that ordinary people want and need. So a priori, we can’t say that an additional dollar of tax revenue is good or bad for ordinary people.

Sure, the government is inefficient at spending money. But the question is, if we reduce “middle-class” taxes–remember, taxes on all households, affecting their income up to $250,000 per year–does that help or hurt ordinary people? The extra dollars you have in your pocket have to be paid for somehow. They can be paid for by raising other taxes (not happening); by cutting non-entitlement spending, which is mainly the defense budget (not happening); by cutting entitlements, which provide net benefits to ordinary people because they are modestly redistributive (not happening); by printing money (not happening–the Fed is printing money, but not to fund the government deficit); or by doing nothing (happening).

Doing nothing, of course, is the old Republican “starve the beast” strategy: cut government revenues to the point where it is unable to do anything. In practice, Republicans have cut revenues and continued to spend on whatever they felt like spending on. But the core of the strategy is that if you cut taxes at every possible opportunity, eventually you will force the government into a crisis where something has to give (and probably it will be a Democratic administration that takes the political hit for cleaning up the mess). And unless American public opinion does an about-face, the thing that will give will be entitlements. (The only other logical possibility is our addiction to low taxes.)

So perhaps with the best intentions, the Obama administration, by making it more likely that the Bush tax cuts will become permanent (just like the AMT fix is permanent), is probably hastening the day when push will come to shove and Medicare will be gutted. The bigger the projected national debt, the more seemingly reasonable people in the middle of the ideological spectrum shake their heads sadly and say something has to be done about Medicare, as if it’s a fact of nature and not a fact of politics. As I’ve said before, no administration has tried harder to control health care costs and thereby protect the future of Medicare. But at the same time, they are digging deeper the hole on the funding side that, politically, is the big threat to Medicare–and to retirement security for hundreds of millions of ordinary Americans.

Apparently Obama is upset at people on the left for insisting on purity. In his view of the world, he drew a line in the sand: he was going to protect tax cuts for the “middle class,” and he succeeded. Maybe he did. Maybe we should be giving him credit for getting what he wanted. But if that’s the case, he’s drawing moderate-Republican lines in the sand. His priorities, as reflected in his policy decisions, are lower taxes (for everyone, not just the rich) and the smaller government that necessarily implies. And that’s why the left is angry.

Originally published at The Baseline Scenario and reproduced here with permission.

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Håvard Halland Håvard Halland

PHåvard Halland is a natural resource economist at the World Bank, where he leads research and policy agendas in the fields of resource-backed infrastructure finance, sovereign wealth fund policy, extractive industries revenue management, and public financial management for the extractive industries sector. Prior to joining the World Bank, he was a delegate and program manager for the International Committee of the Red Cross (ICRC) in the Democratic Republic of the Congo and Colombia. He earned a PhD in economics from the University of Cambridge.