Make the Tax Cuts Permanent

In the waning days of the Democratic House majority, Congress has at least one major question to resolve—whether to extend the Bush tax cuts. While the Obama administration and most Democrats agree that the cuts for low and middle-income taxpayers should be made permanent, they would allow those for high-income households to expire, increasing the top two income tax rates and the capital gains rate. They claim a tax hike is needed to reduce the deficit, but allowing these tax cuts to expire would not solve the long-term deficit problem and could even make it worse.

The GOP’s defense of the tax cuts is largely premised on the argument that, in the words of Rep. Paul D. Ryan, Jr., “You don’t raise taxes during a recession.” While some have argued that the money that would be “spent” on the rich should instead be used for a payroll tax holiday or a rebate for all citizens, tax cuts tend to be most effective when they alter incentives, and the best way to do that is by permanently reducing rates. Increasing tax rates would discourage the investment needed to create new jobs just at the moment it is most needed.

Even some Democrats might agree that taxes should not be raised during a recession, but to say that they should be made permanent may appear tenuous given the budget deficits projected in the future. Claims that the tax increase would generate $678 billion over ten years are likely overstated given its effect on incentives, but allowing these cuts to expire—despite the rhetoric of some Republicans—would lead to an increase in revenues that would reduce the level of the deficit in the coming years.

Raising taxes, however, is not the solution to the budget crisis; to determine the appropriate solution, it is necessary to understand the nature of the crisis itself. For one thing, the fiscal year 2010 deficit of $1.6 trillion is largely due to mammoth stimulus spending and a temporary decline in revenues because of the recession. The deficit in 2007 was just $161 billion, and that year saw the beginning of the Iraq troop surge.

The greatest cause for concern is not the current level of the deficit but its unsustainable rate of growth in the long run, which is due to ballooning entitlement obligations. Thanks largely to medical technology and the aging population, the Congressional Budget Office projects that spending on Medicare, Medicaid, and Social Security will grow from about 10 percent of GDP today to about 16 percent by 2035, causing the public debt to mushroom from 53 to 200 percent of GDP.

Unless the American public is willing to stomach a tax increase worth six percent of GDP between now and 2035—and even more after that—Congress should set a fixed level of taxation, such as the one we have now, and reform entitlement programs to bring the budget into long-term balance. For those who are concerned about distributional consequences, a first step might be to reduce or cancel Social Security and Medicare benefits for the wealthy.

From a political standpoint, the proposed tax increase could actually worsen long-term budgetary prospects because of how it would impact the composition of federal revenues. According to the Washington-based Tax Policy Center, about 47 percent of Americans paid no federal income taxes at all in 2009—either their incomes were too low, or they qualified for enough credits, deductions, and exemptions to eliminate their liability. The bottom 40 percent, on average, made a profit from the income tax, meaning they got more money in tax credits than they would otherwise have owed in taxes. Instead of a bill, the government sent them a check.

These citizens might pay excise taxes, but these only amount to three percent of total revenue, and are often levied on recreational goods. While all working citizens must pay taxes for Social Security and Medicare, they directly benefit from these programs when they retire.

What this means is that 47 percent of the country has virtually no stake in funding the military, benefits for veterans and federal retirees, federal support for education, infrastructure, and numerous other aspects of federal spending not directly tied to workers’ retirement welfare. And they have little stake in Medicare outpatient and prescription drug services, which are funded predominantly by general revenues. The top 10 percent of earners, by contrast, contributed about 73 percent of income taxes in 2009, which is to say nothing of the effects of corporate and estate taxes paid disproportionately by the rich.

The wealthy are certainly not oppressed by the tax code or any other aspect of government. But an analysis of the causes of the budget crisis should account for the fact that the federal government is all benefit and no cost for nearly half the population, and very little cost for many others. When elected representatives must answer to these citizens as well as those footing the bill, is it any wonder they have been so fiscally irresponsible?

Raising taxes on upper-income citizens would only exacerbate this problem by increasing the share of federal revenues contributed by the few at the top. If Congress wants to raise taxes, it should raise them for everyone so that more citizens have at least some stake in paying for their government. Without entitlement reform, this will be not a suggestion but a necessity.

Peyton R. Miller ’12 is a government concentrator in Winthrop House. His column appears on alternate Wednesdays.