In Sunday's Washington Post, Bill Gale of the Tax Policy Center wrote an article describing "myths of the expiration of the Bush tax cuts" (which are really the intended Obama-Pelosi-Reid tax hikes of 2011). Below is some commentary, but you should read his article first before proceeding.
The tax hikes will stifle economic growth and job creation. Gale notes that avoiding the 2011 Obama tax hike would not be very effective stimulus. While this might or might not be true, he confines his analysis to a Keynesian world of consumption and demand. What this ignores is the effect that higher marginal tax rates on work, saving, and investment will have on incentives. Raising the capital gains rate from 15 to 20 percent, and the dividends rate from 15 to 39.6 percent, for example, will depress the after-tax rate of return on stocks. This will, over time, make stocks less valuable and lower the size of everyone's nest egg (tax-deferred or not). The same can be said for small businesses, high-end wages, other savings, etc. These effects are arguably more important than Keynesian demand analysis.
The tax hikes will affect the majority of small business profits. Gale argues that the effects of higher marginal tax rates on small business is overstated. We disagree. Even if one confines the argument to sole proprietors only (the most undisputed sample), IRS data shows that 34 percent of these profits are earned in households making more than $200,000 per year. These are the households, by and large, which will see marginal rate hikes even under the Obama budget (33 and 35 brackets rising to 36 and 39.6 percent). Since small business owners pay profit taxes on their personal tax forms, to raise the owners' tax rates is to raise the tax rate on the small business' profit. Adding in pass-through entities like S-corporations and partnerships loops in the majority of small business profits.
The tax hikes will lead to more government spending, not less. Gale believes that raising taxes will lower the deficit, which will lower interest rates. There's a good argument that this theory is incorrect, but we don't even need to go there. Gale is assuming a unicorn–namely, that governments will take the higher tax revenue (assuming there is any after the economy is wrecked), not spend it, and use it to make deficits and debt smaller. This is absurd. In 1983, President Reagan was promised $3 in spending cuts for every $1 in tax hikes. President George H.W. Bush was promised $2 in spending cuts for every $1 in tax hikes. The tax hikes went through–and spending went up. Raising taxes makes government spending go up (like pouring gasoline on a campfire), and ignoring that reality is to miss a lot of how politics works in the real world.
Spending is to blame for deficits, not tax revenues. Gale is correct that tax revenues are not to blame for deficits this decade. In fact, CBO projects that tax revenues will come in at their historical average if all tax hikes are avoided, and well above it if they are all enacted. The intermediate-term deficits are caused by spending, which remains well above its historical average for the entire decade.
- Reforming entitlement programs without tax hikes is a better idea than benefit cuts and tax increases. After getting the intermediate-term budget analysis largely-correct, Gale drops the ball on the long-term budget issue. The explosion of entitlement spending means that federal spending over the next few decades will grow from 20 percent of GDP to 40 percent of GDP (I'm using round numbers here). Federal taxes should remain just a hair shy of 20 percent of GDP during this period. This creates massive budget deficits, but that's hardly the fault of taxes, which will remain at the historical revenue yield. It's entirely the fault of spending. The solution to the entitlement spending problem can be found in Congressman Paul Ryan's (R-Wisc.) "American Roadmap" plan.