Wednesday, December 8, 2010

Details of the tax cut compromise

Ironically, the compromise may save Obama's presidency. (Steve Jurvetson)

For many observers, the fact that the Obama Administration and congressional Republicans reached a compromise on extending the Bush tax cuts was not a surprise.  The big surprise was how quickly the agreement came.

President Obama himself has accepted the fact that when tax rates drop, the government’s tax revenues actually increase.  On the other hand, as tax rates increase the government actually takes in less money.  President Obama’s response to these facts was that tax rates should be increased for “fairness.”  Realizing the effect of low tax rates, it is unsurprising that President Obama would temporarily avert a tax increase in order to help bring the economy out of the recession. 

In spite of President Obama’s realization of the power of low tax rates, congressional Democrats complain about the cost to the government of extending the low tax rates for the wealthy.  This is a hypocritical position on two points.  First and most obvious, the Democrats object to the cost of low taxes, but they have no objection to the cost of their pet programs.  Whether it is the extension of unemployment benefits in the compromise, which will cost $56 billion, or the stimulus package, which tipped the scales at $787 billion, cost is not an object unless it applies to tax cuts.

Second, most Democrats supported extending the low tax rates for the middle and lower class, but opposed extending the low tax rates for the wealthy.  The total cost of extending the current tax rates is $383 billion.  The cost of extending the high income tax rates is $75 billion.  This means that the cost of extending the rates for the lower and middle class, at $308 billion, is far more expensive that extending the upper income tax rates.  If they were truly worried about fiscal responsibility, the Democrats would object to the entire package.

The effect of the compromise, if it passes, will likely be to help lift the economy out of the doldrums (although the temporary nature of many aspects of the plan does limit the possibilities for long-term growth).  With the knowledge that paychecks will not shrink, at least in the short term, taxpayers will have more money to spend or invest than they would have otherwise.  There are also other aspects to the deal that will help the economy such as a temporary reduction in the Social Security tax, a temporary fix for the Alternative Minimum Tax (AMT), a compromise that would restore the estate tax at a lower rate, and extensions to several tax credits.

The one aspect of the plan that may actually damage the economy is the part that is most supported by Democrats.  Many economic studies show that extending unemployment benefits may actually be linked to higher unemployment rates.  While it seems compassionate to give money to the unemployed, it actually provides them with an incentive to not seek new jobs until their benefits are about to expire.  This concept is confirmed by the “funemployed,” laid off workers who enjoy a leisurely lifestyle financed by the taxpayers.

Similarly, generous and long lasting unemployment benefits discourage workers from taking lower paying jobs.  Some jobseekers are offered jobs, but because they are receiving generous benefits, can afford to turn them down and keep seeking jobs with pay and benefits commensurate with their old jobs.  Little do they realize that jobs with the compensation they are seeking no longer exist.

Most opposition to the deal seems to be coming from the Democrats who feel betrayed by Obama’s temporary abandonment of class warfare.  Nevertheless, many Democrats were on record as supporting an extension of the low Bush-era tax rates even before the compromise.  Georgia’s three Democratic congressmen, including lame duck Jim Marshall, support the compromise.  Georgia’ Republican delegation is unlikely to oppose the deal.

Ironically, the tax cut compromise may boost the economy to the point that Obama’s approval rating recovers and his chances of re-election improve.  It will be up to Republicans to remind voters that under the Democratic agenda the economy remained stagnant.

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