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Economic Effects of 2011 Tax Hikes: Killing One Bird with Two Stones

Posted By Kathryn Nix On August 10, 2010 @ 3:30 pm In Economics | Comments Disabled

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Next January, tax rates will increase—even though the country remains in a recession—unless Congress takes action. The Obama Administration’s solution is to extend the 2001 and 2003 tax cuts except for families earning $250,000 and individuals earning $200,000.

But is this the right move from an economic perspective, and the right choice to promote deficit reduction? In both cases, the right answer is to extend the tax cuts for all Americans—including top earners.

In a recent article [2] in The New York Times, Robert H. Frank claims that proponents of keeping current tax rates want to do so “because the economy needs additional stimulus.”

This conveniently, if sloppily, erects a neat straw man to knock down. Obviously, extending current tax rates won’t serve as additional stimulus. As economist Arthur Laffer explains [3], “As a result of higher tax rates on those people in the highest tax brackets, there will be less employment, output, sales, profits and capital gains—all leading to lower payrolls and lower total tax receipts. There will also be higher unemployment, poverty and lower incomes, all of which require more government spending. It’s a Catch-22.”

According to Laffer, the deleterious effects that President Obama’s tax increases would have on the economy will add to the fiscal obligations of the federal government.

Frank claims that increasing taxes would “generate revenue that could be used to bolster spending in a host of ways that would be useful even apart from the stimulus effects,” but in reality, this increase in revenue would not go nearly as far as he hopes. For Frank, the end game is more federal spending—not deficit reduction.

Finally, Frank claims that raising taxes on the wealthy would not affect consumption because, rather than reducing spending, higher taxes would come out of savings for top earners. But when the wealthy save, this money doesn’t disappear from the economy—rather, it is invested, which results in more employment and higher wages.

No matter how you slice it, extending tax relief is the right choice to help stabilize the economy. And even if you don’t put much faith in the incentive effects of marginal tax rates, no economic theory suggests raising taxes during a recession. To tackle deficits, lawmakers need to address their true cause: skyrocketing spending [4].


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URL to article: http://blog.heritage.org/2010/08/10/economic-effects-of-2011-tax-hikes-killing-one-bird-with-two-stones/

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

[2] recent article: http://www.nytimes.com/2010/08/08/business/economy/08view.html?_r=1

[3] As economist Arthur Laffer explains: http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748703977004575393882112674598.html

[4] skyrocketing spending: http://www.heritage.org/Research/Commentary/2010/07/The-Bush-Tax-Cuts-and-the-Deficit-Myth

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