By: Bloomberg Businessweek
October 7, 2010
Hoping to help save the Democratic majorities in November, the administration is stressing fairness in tax cuts
President Barack Obama has shifted his central argument against the Bush-era tax cuts to make the income gap as much a voter concern as the budget gap.
Since Sept. 3, Obama has chided Republicans for wanting to extend tax cuts for "millionaires and billionaires" -- a line he repeated in a morning television interview, a weekly radio address, backyard chats in Des Moines and Albuquerque, and three times during one speech at a community college in Cuyahoga County, Ohio. Before then, administration economists cast taxing the wealthy largely as a matter of fiscal prudence -- a way to free up $700 billion from the deficit over the next 10 years.
Administration officials are betting that emphasizing fairness will resonate with voters in the November elections as Democrats struggle to save their majorities on Congress. The pitch is bolstered by research from Emmanuel Saez, a University of California economist, that shows middle-class incomes stagnated in the five years before the recession, then suffered the biggest drop since the Great Depression.
"If you start talking about fairness, then it's clear," said Alan Krueger, the Treasury Department's chief economist. "The middle class has struggled over the past 10 years. Given what's happened in recent decades, given who benefitted from past tax cuts, which group would you protect?"
The cuts -- which expire Dec. 31 -- have become a pivotal battle for a president sent to Washington promising to help the middle class. Both Democrats and Republicans want households earning less than $250,000 to keep current tax rates, which were enacted in 2001 and 2003 under President George W. Bush. The debate is whether to raise taxes on the top 2 percent to 3 percent of American wage earners.
Jennifer Duffy, political analyst at the Cook Political Report, said Obama's change in tactics is calculated to draw in supporters from 2008. Polls show that Republicans are poised for significant gains in November. "I think the shift in rhetoric on tax cuts is designed to motivate the base and get them invested in this election,"
Duffy said. She said the Democrats' ability to get out the vote "may make the difference between having a horrible night and just a bad one."
Republicans say Obama is engaging in class warfare and argue that higher taxes on the rich will slow investment and delay hiring. "Where is the fairness at stifling the job creators who are going to be offering jobs -- to those very people that the president is claiming to be advocating for," said Republic Representative Peter Roskam of Illinois, where unemployment of 10.1 percent tops the national rate.
Obama's tax-cut strategy dates back to the 2008 presidential campaign, when he and Vice President Joseph Biden saw middle-class stagnation as one of the economy's biggest problems, said Jared Bernstein, Biden's chief economic adviser. "They were getting this message from middle-class families that something's wrong," said Bernstein, who has a doctorate in social welfare from Columbia University and has written books on inequality trends, including "Crunch: Why Do I Feel So Squeezed?" in 2008. "A big motive for their economic policy to this day is fixing that," he said.
White House economists also drew on the work of Saez, an economist from the University of California, Berkeley, who spent years analyzing Internal Revenue Service data. Last week, the 37-year-old was named a MacArthur Foundation Fellow, receiving a so-called genius grant for his work analyzing income and tax policy.
Saez reviewed income-tax data from 1913 to 2008 and produced a narrative that private-sector economists and even skeptics of Obama's strategy have found worth reading. Updated in July, the study details a measurable "disconnect" between wealthy Americans and everyone else, Saez said in an e-mail. "Striking it Richer: The Evolution of Top Incomes in the United States," found that middle and upper-income Americans also experienced the recession differently. His research resonated with Obama's team and triggered e-mail exchanges between Saez and several administration economists.
According to the study, top income earners sustained a less-damaging shock than in other downturns -- and sustained less damage than the middle class. The top 1 percent of American earners captured two-thirds of all income growth from 2002 to 2007. Middle incomes stagnated during the same time period and then plunged 6.9 percent during the recession, Saez found.
Saez also found the top 1 percent, who earned $368,000 or more, saw income fall by 19.7 percent from 2007 to 2008. The fall was less than the 21.2 percent drop those earners had in the first year of the recession that began 2000, Saez said.
The first year of the current recession came after a five-year boom for the top earners, who posted 10.3 percent real annual earnings growth, Saez said. So the rich were much better positioned to withstand the financial crisis, he said.
Treasury Secretary Timothy F. Geithner this summer contended that raising taxes on the rich will signal to investors that the U.S. won't let its budget deficit balloon indefinitely. The Congressional Budget Office expects the deficit to exceed $1.3 trillion in fiscal 2010, which ended Sept. 30, nearing the $1.4 trillion record set in 2009.
Republicans and other economists dispute the Obama rationale that the rich -- whose tax rates would rise from 33 and 35 percent to 36 and 39.6 percent -- should pay for past good times.
Raghuram Rajan, an economist at the University of Chicago who wrote "Fault Lines," a book published this year that examines the financial crisis and income inequality, said Obama's tax strategy is politically "opportunistic" and won't fix the structural aspects of inequality.
As yet, the administration hasn't done enough to improve education and unemployment benefits, both critical to the recovery, he said. "We have a two-tier recovery," Rajan said in a telephone interview. "It accentuates the earlier problems that we had."
James K. Galbraith, a University of Texas economist and author of the 1998 book "Created Unequal: The Crisis in American Pay," said the Obama strategy should be seen as a first step toward rebalancing the tax system. "We don't need higher taxes, we need better taxes,"
Galbraith, a former executive director of the Joint Economic Committee, said in a phone interview. "Putting income in the hands of people who need it, and not in the hands of people who don't, is the right economic policy."