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Tax Cut Myth Busting, Round 2

Posted By J.D. Foster, Ph.D. On August 3, 2010 @ 5:00 pm In Economics | Comments Disabled

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Bill Gale’s discussion of the five myths about the Bush tax cuts was an unusually slanted piece [2] from a normally straight-shooting liberal economist. With respect to an old friend, a little further myth busting is called for.

Tax Relief as Stimulus
Gale refers to the proposition that extending the tax relief “would be a good way to stimulate the economy” as a myth. In doing so, he conveniently erects a bit of a straw man. Continuing current policy cannot add much to stimulus except by erasing a debilitating source of uncertainty regarding tax policy. The real issue is how much damage a tax hike would inflict on a weak economy.

To shed light on this question Gale returns to the same flawed approach used by the Administration to explain how government debt creates jobs. All wrapped up in questions of who spends the biggest share of income and who is most likely to save, he manages to ignore the fact that we have this little thing called a financial sector that exists primarily to intermediate savings into investment.

Would allowing the tax relief to expire sink the economy into depression? No. Will it hurt? Yes.  Is it smart when unemployment is hovering around 10 percent? Are you crazy?

Slamming Small Businesses
His second myth is the nostrum about small businesses facing tax rates. The superficial argument Gale offers suggests higher tax rates are largely irrelevant to small businesses. He argues that “less than 2 percent of tax returns reporting small business income” would be subject to the higher taxes. He’s right, but there’s a lot more to the story than he admits.

Last year, I reported “small business income” earned for writing a couple articles for outside publication. I suspect Gale did likewise. That means our tax returns reported “small business income.” A great many Americans earn a few bucks on the side. Much of that is small business income. And that means we have millions of tax returns earning small business income. But we’re not really small businesses. We don’t hire people. We don’t offer services widely.

True small businesses have employees. They invest in machinery. They offer goods and services widely. And the successful ones earn significant sums to compensate for the risks of running the business, earning a return on capital invested, and to grow. And because they earn significant sums, successful small businesses earn the bulk of small business income. So, while only a small portion of taxpayers reporting small business income would face Obama’s higher rates, those facing the higher rates are the successful, growing, and hiring small businesses the economy needs to grow. That’s a big part of the reason allowing the tax relief to expire would hurt the economy.

Effects on Long-Term Growth
Tax relief, such as lower top income tax rates and lower rates on dividends and capital gains, helps long-term growth by encouraging work, investing, and saving. Gale agrees! Or, as he puts it, “this isn’t the whole story.” Then he argues that the deficit spending that occurs because spending outstrips revenues leads to higher interest rates. This is a fascinating argument for any liberal to make while defending Obama’s serial trillion dollar deficits. Essentially, debt due to tax relief is bad; debt due to spending is good. You’re serious, right?

Bush Tax Cuts and the Deficits
Many commentators have tried to argue that the Bush tax cuts caused the deficits of the past decade, and are primarily responsible for the deficits projected for this decade. Gale neatly dispatches both myths. Enough said.

Tax Relief, Entitlements, and the Long Term
As Gale notes, “the deficits we face over the next decade reflect a fundamental imbalance between spending and revenue.” He’s right, but the next decade isn’t the long term and tax relief isn’t the cause of the imbalance.

While revenues are projected by Obama under current policy to return quickly to historical levels, spending does not, hence the fundamental imbalance we now face. The issue can only be described as partly attributable to the tax relief if one first asserts that the higher spending is both necessary and appropriate, in which case higher taxes would follow. In the long run, we add to this fundamental imbalance the consequences of unaffordable entitlement programs that no tax hike can remedy.

Rather than throw even more chaff into the debate, Obama and friends could state their case simply and affirmatively and let the taxpayers decide what they want. Doing so might have run something like this:

The tax cuts should be allowed to expire because government spending has and will continue to outstrip revenues and that spending is necessary and appropriate. True, the tax relief will hurt the economy in the short-run and the long run, but we’re not sure by how much and in my view that is a cost and risk worth bearing. Further, the rich earn too much money in this country and Obama was right when he said we need to spread the wealth around a bit. Call it Robin Hood if you like, but this is my vision for America.

Had Gale said something like this, I would disagree with him strongly. But I would respect his forthrightness in stating his views and we could then have an honest discussion sans myths.


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URL to article: http://blog.heritage.org/2010/08/03/tax-cut-myth-busting-round-2/

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[1] Image: http://www.foundry.org/wp-content/uploads/TaxCalculator.jpg

[2] an unusually slanted piece: http://www.washingtonpost.com/wp-dyn/content/article/2010/07/30/AR2010073002671.html

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