The New York Times
By: David Leonhardt
November 2, 2010
WASHINGTON -- The Bush tax cuts expire in 58 days.
If Congress does not take action before then -- Dec. 31 -- taxes will go up for nearly all households. That has the potential to cause both political and economic problems. So Congress, even a lame-duck, repudiated Congress, is likely to act.
But what will it do?
Given the mood of the voters, the outcome will probably be closer to the Republicans' wishes (extending all the tax cuts) than President Obama's (extending all the cuts for households making less than $250,000 a year while allowing most of the cuts for households above that threshold to expire). Yet Democrats may still have enough sway to force some negotiation.
Here are five compromises worth considering, on what will be the first big order of business for Congress after the election:
FISCAL RESPONSIBILITY The tax cuts will be an early test of whether members of Congress meant what they said about the deficit during the campaign.
The cuts represent a huge share of the country's medium-term deficit. Letting them all expire would bring in $260 billion a year over the next decade -- which would go more than halfway toward getting the deficit down to a level economists think is sustainable. Of that $260 billion, the cuts that both parties favor account for about $200 billion. The cuts for the affluent make up the remaining $60 billion.
One option for Democrats is to accept the cuts for the affluent only if they are offset with deficit savings elsewhere. In the current political environment, an obvious place to look for savings is discretionary spending, which is all federal spending except for interest payments and entitlements like Medicare and Social Security.
Cutting earmarks, those pet projects of members of Congress, in half would save $8 billion a year. Canceling NASA's missions to the moon and Mars would save $4 billion. Reducing farm subsidies could save $10 billion. Cutting wasteful weapons programs could save tens of billions -- and, intriguingly, some Tea Party-backed candidates, like Rand Paul of Kentucky and Representative Paul Broun of Georgia, say they favor military cuts.
CLOSE LOOPHOLES Another way to cut the deficit is to reduce something known as tax expenditures. These are the loopholes, deductions and credits that allow businesses and households to avoid paying many taxes.
The rising number of tax expenditures is the reason the tax code has become so maddeningly complex. In all last year, they cost the federal government $1.05 trillion. To put that in perspective, the sum total of all personal income taxes paid was only $915 billion.
Politically, expenditures are a promising target, because reducing them seems to be the one way Republicans are open to a tax increase. Why? Many in the party consider expenditures to be -- as the name suggests -- a form of spending. "If Congress is serious about cutting government spending," as Martin Feldstein, the Republican economist, has written, "it has to go after them."
The trick will be to avoid cutting expenditures that benefit the middle class and poor while cutting taxes for the wealthy, thus aggravating income inequality. Among the possibilities suggested by the Committee for a Responsible Federal Budget, a research group, are the tax exclusion for individual income earned abroad (which costs $6 billion a year); oil and gas subsidies ($3 billion); and special tax treatment of Blue Cross and Blue Shield ($700 million).
Whatever the details, any spending cuts or tax increases could be delayed for a few years, to avoid the risk of making a weak economy weaker.
JOBS, JOBS, JOBS If anything, the best near-term move is to cut taxes further and to spend more. Unfortunately, extending all the Bush tax cuts is not likely to help the economy much, given that the well-off save more of their income than other households. Just consider what happened after the Bush cuts became law: job losses continued for another two years and growth after that was mediocre.
Mr. Obama recently backed several traditionally Republican ideas, like business tax cuts, that would probably do more to create jobs. He has also called for spending on highways and other infrastructure. Packaging these proposals with the Bush tax cuts could give the economy a needed lift.
A MILLIONAIRES TAX Right now, the 400,000th dollar earned by a surgeon is taxed at the same 35 percent marginal rate as the four millionth dollar earned by a hedge-fund manager. This makes little sense, and it runs counter to how the tax code worked for much of the 20th century.
The top brackets once distinguished between the merely affluent and the truly rich. In 1960, for example, the top marginal rate (of 91 percent) started at $400,000, which is the equivalent of almost $3 million today.
Congress could take a small step back in this direction by extending all the Bush tax cuts for households making less than $1 million a year. At the same time, though, a new tax bracket would start at $1 million. The marginal tax rate could be 39 percent, which was the top rate under Bill Clinton. The Financial Times recently endorsed such a plan. It would probably cost something like $30 billion a year, rather than the $60 billion for extending all the upper-income cuts.
Lest you worry about millionaires, they'd still be doing just fine. They would indeed get to keep part of the Bush tax cut -- that part that applied to their first million dollars of income. Their total federal tax rate would still have fallen far more in the last three decades than the rate for any other group. And millionaires have received much larger pretax raises over that time than the middle class or the poor.
A TACTICAL RETREAT If all these compromises fail, a final possibility remains. Congress could permanently extend the tax cuts for households making less than $250,000 a year and temporarily extend -- maybe for two years -- the upper-income cuts. True, this would not do much to reduce the deficit or help the economy. But it would increase the odds that the upper-income cuts would eventually disappear.
As you may have heard, the country is facing an enormous long-term budget deficit. Every year that the Bush tax cuts are extended makes that deficit all the larger.