December 8, 2010

Taxes and the Art of the Possible

Barack Obama exhibited this week what Machiavelli called the essential quality of a successful statesman, “virtu,” or the capacity to advance a society’s vital interests while respecting the constraints of conditions beyond his control. The vital interest at stake here is a decent economic expansion that improves the circumstances of the vast majority of Americans, and the critical condition beyond the President’s control was the Republicans’ ability to block any tax increase for a very small minority of high-income households. While this week’s tax deal isn’t nearly enough to drive a robust recovery, it should be good economic news for most Americans.

Yes, the President agreed to two more years of the Bush tax cuts for very well-to-do people, covering their overall incomes, dividends and capital gains, and sheltering all but the very richest estates from inheritance taxes for two years. But those were concessions to conditions beyond his control, since without them, there would have been no action at all. Moreover, in return the President won the GOP leaders’ acquiescence to some significant help for nearly everyone else.  Beyond two more years of lower tax rates for average Americans, he secured expanded tax credits for parents putting their children through college, a one-year payroll tax reduction for working people, an expanded Earned income Tax Credit for working poor families, and an additional year of unemployment benefits for millions of out-of-work Americans.  

To be sure, that won’t be enough to drive a strong expansion. That still requires difficult measures to correct the distortions that brought on the original financial crisis and still continue to dampen the expansion.  A strong revival of consumer spending, of the sort that powers most early expansions, still depends on steps to stabilize housing prices. And while this week’s deal includes another dose of tax breaks for business investment, a surge in business spending will have to wait for consumers to begin spending freely again and for lenders to clear their books of billions of dollars in real estate-related investments that continue to deteriorate. Nevertheless, the deal passes the basic test of sound economic policy by moving the economy in the right direction, and should help nudge the jobless rate down a bit. 

The temporary nature of these measures also provides intriguing opportunities for Democrats.  The payroll tax reduction would expire one year from now, just as the 2012 campaigns get going.  Ultimately, neither party would let that happen, but the President could use its prospect to drive progressive social security reforms. For example, the 2 percent cut in the payroll tax rate for employees could be phased out very gradually, and the lost revenues could be offset by raising the cap on the wages subject to the tax. The 1983 social security reforms set the cap to cover 90 percent of all wages, rising each year at the same rate as average wages. But since the wages of those at the top have grown much faster than the average, today the cap covers only 85 percent of wages. Push it back to 90 percent, as the Bowles-Simpson Commission has proposed, and we could phase out the “temporary” tax rate reduction over a decade’s time and take a big step towards guaranteeing the system’s long-term solvency.

Moreover, the tax cuts for high-income Americans could be more vulnerable politically two years from than they are today. It’s safe to say that the deficit will be a hot-button issue in 2012, and with the Bush tax cuts now set to expire in January 2013, the election-year deficit debate will include heated arguments over who should have to pay higher taxes. According to current polls, at least, the public’s answer is those high-income folks. 

While the loudest complaints about the deal have come from progressive Democrats, the real question is why the Republicans agreed to it. For all of the GOP’s talk about jobs and deficits, the deal exposes their real bottom line: Preserve at almost any cost lower taxes on the incomes of the top 2 percent of Americans and on the estates of the top 0.5 percent. The deal equally highlights the President’s priorities — tax relief for the middle class, and help for the unemployed and the poor. And if the economy finally begins to gather steam by 2012, the contrast embedded in this week’s deal might well boost the President’s prospects.