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Debt Held by the Public Under CBO鈥檚 March 2010 Baseline and CBO鈥檚 Estimate of the President鈥檚 Budget (Percentage of gross domestic product) - from

All of my readers know how I feel about the Bush tax cuts. I鈥檝e never liked them鈥搉ot from day one. They were too costly, too skewed to the rich, and did too little to make the tax system more efficient. I disliked them even more as a Democratically-controlled Congress during the Bush Administration couldn鈥檛 muster the courage to let them expire as scheduled when challenged by the Republican charge of 鈥渢he largest tax increase in American history.鈥� But the final kick in my stomach was when a new president who campaigned on the 鈥渃hange鈥� we could believe in promised to continue the same tax cuts that he himself criticized as being fiscally irresponsible and yet not his fault.

So of course I want President Obama to break his stupid campaign promise to extend the Bush tax cuts for all households with incomes below $250,000. The tax cuts are still unaffordable ( that even the <$250K portion would cost $2.2 trillion over ten years鈥揳ll but around $400 billion of the full complement of Bush tax cuts), would still go mostly to the rich (high income households 鈥渕arch鈥� through all the lower tax brackets after all and hence get the highest dollar benefit of lower-bracket rate reductions, and they also benefit the most from the lower rates of taxation on capital income), and would still do nothing to broaden the tax base to make the system more efficient.

But I submit that even people who love the Bush tax cuts and believe in 鈥渟upply-side economics鈥� (even the extreme Laffer-curve view) and sympathize or even participate in the 鈥渢ea party movement鈥� and just generally like low taxes (or dislike taxes in general) should want President Obama to break his campaign promise.

Why?

Because many of these same people who like low taxes also claim to not like the large budget deficits we鈥檙e running now or the unsustainable fiscal path that lies way out in front of us鈥� and because President Obama has also promised to get the deficit down to a 鈥渟ustainable鈥� level of around 3 percent of GDP in five years. But the President鈥檚 own budget, which includes the deficit-financed extension of those 鈥渕iddle-class鈥� Bush tax cuts (that $2.2 trillion worth), isn鈥檛 consistent with such a low deficit. , the deficit would be 4.3 percent of GDP in 2015鈥揳 level considered unsustainable because it exceeds the typical rate of economic growth. That鈥檚 why the President鈥檚 budget also proposed a fiscal commission that would recommend policies (by the end of this year) to help squeeze out the remaining 1 to 1.5 percent of GDP difference.

Most of that gap will have to be filled with new revenues, because within the next five years there鈥檚 hardly any hope of reducing the deficit by cutting spending. Cuts in discretionary spending are too small to make much difference. Cuts in mandatory spending via the big entitlement programs aren鈥檛 going to happen soon鈥揵oth because that鈥檚 politically infeasible and because on health reform we will barely be getting started in five years (and will really just be figuring things out as we go along).

So when the President says he wants to get the deficit down to 3 percent of GDP by 2015, most of the heavy lifting will have to come from higher taxes鈥揳nd I mean higher taxes other than the higher taxes on the rich that the President already proposes in his budget and that were already included in the health reform bill. And these additional higher taxes will have to come despite the President鈥檚 promise to not raise taxes on those households with incomes under $250,000.

Enter the very nice new analysis of the , in a paper called Len Burman, the TPC鈥檚 former director (now at Syracuse University鈥檚 Maxwell School), cited this work in before a Ways and Means subcommittee. Table 2 in the 鈥渄esperate鈥� paper shows that the Administration鈥檚 budget proposals (on both the spending and revenue sides of the budget) fall $534 billion short of the Administration鈥檚 3 percent of GDP deficit goal in 2015. (In contrast, current law, which assumes all the Bush tax cuts expire as scheduled at the end of this year, would fall just $40 billion short of the goal.) Table 3 shows how marginal tax rates (the tax rates on the next dollar of income earned鈥搕hose that affect economic incentives) would have to be increased in order to reduce the deficit to that 3 percent of GDP goal in 2015. If after the Bush tax cuts are first extended (as assumed in the Obama Administration鈥檚 鈥減olicy baseline鈥�), then all marginal tax rates are raised proportionately to get us to 3 percent of GDP deficits in 2015, the top marginal rate would rise from its current 35 percent rate to 48 percent. On the other hand, if only the top two marginal tax rates鈥搕hose affecting primarily households above $250,000鈥揷an be adjusted to achieve the deficit goal, then the top marginal rate would have to rise from 35 percent to 77 percent (and the second highest rate would rise from 33 percent to 72 percent). The larger the population exempt from the tax increase, the more the marginal rate has to rise on those left to pay the higher tax.

Table 7 in the 鈥渄esperate鈥� paper shows that the strategy of limiting deficit-reducing tax adjustments to the top two tax brackets is a highly progressive one. Compared with either current law where all the Bush tax cuts expire as scheduled (and where revenue is a little short of the 3 percent of GDP deficit goal) or current policy with all of the Bush tax cuts extended (and where revenue is way short of the deficit goal), the 鈥淥bama dual promise鈥� strategy raises average tax burdens significantly for only the top 1 to 5 percent of households and reduces or holds steady the tax burdens on all others.

But I鈥檓 going to step out of character and sound like a supply-sider for a minute here, and argue that despite having this very steeply progressive distributional pattern, the 鈥淥bama dual promise鈥� tax policy would not necessarily be a 鈥済ood deal鈥� for even the vast majority of households not in the top 1 to 5 percent鈥揵ecause of that 77 percent top marginal tax rate. Having that pattern of marginal tax rates that rises so steeply at the top (go back to Table 3, bottom panel, last column on the right)鈥搘ith rates of 10, 15, 25, 28, 72.4 and 76.8 percent鈥搘ould create huge disincentive effects on labor supply and saving. See, all economists are 鈥渟upply siders鈥� in a sense, because we all believe that marginal tax rates affect economic decisions at the margin. Not all economists, however, are radical, right-wing, 鈥淟affer-esque鈥� supply-siders who believe that increasing tax rates lead to decreases in revenue. But that is because for most of U.S. history, we haven鈥檛 had marginal income tax rates high enough to worry about the Laffer curve theory. Some empirical work on this (done decades ago by my dissertation advisor, , in fact), has indicated that the revenue-maximizing tax rate is far above our current highest rates of 30-40 percent鈥搃n fact, in the鈥�70-80 percent range. Hmmm.

Why did the 鈥渟upply siders鈥� of the 1970s and 80s worry about high marginal tax rates? The theory was that high rates were so stifling to economic growth that if you reduced these tax rates, the benefits to the economy would 鈥渢rickle down鈥� from the rich people enjoying the tax cut down to the middle-class people who would get employed by the growing companies the rich people were investing in.

In theory, 鈥渢rickle down鈥� can work in a negative way, too. If marginal tax rates are raised to prohibitive, other-side-of-Laffer-curve levels, then the labor supply and saving of the rich are reduced, overall economic growth is reduced, and employment and wages鈥揺conomy wide and throughout the income distribution鈥搒uffer. And on top of that, revenue falls (because we鈥檙e on the wrong side of the Laffer curve), which raises the government deficit, reduces national saving, and in turn reduces economic growth. And the effects of economic growth, particularly on the down side, are very broadly distributed.

I know it must seem odd that I would pull out this supply-side argument as a reason why even middle-class and lower-income households should hope the President doesn鈥檛 keep his 鈥渘o middle-class tax increase鈥� promise. But I鈥檓 saying so because it鈥檚 just not good or sustainable tax policy to rely on such a huge increase in taxes on such a small percentage of the population to fund a cause (deficit reduction) that would otherwise have large and broadly-distributed benefits.

I get back to my position that the easiest way to stick with current-law baseline revenue levels (which get us close to the 3 percent of GDP deficit goal) is to stick with current law, where all of the Bush tax cuts expire as scheduled at the end of this year. No taxes would need to be reformed, and in fact no tax legislation would need to be passed and signed! Of course, a better way would be to stick to current-law revenue levels by reforming the tax system鈥揵roadening the tax base to make it more efficient so that marginal tax rates would not even have to come up and we could still raise more revenue to achieve our deficit goal. But people (regular people and policymakers) seem to forget that if we let the Bush tax cuts expire, in the 鈥渨orst鈥� (or laziest) case we just go back to Clinton-era tax policy, which really isn鈥檛 so bad. In fact, if you go back to the 鈥渄esperate鈥� paper and Table 3, the first two columns on the left in the bottom bank show marginal tax rates if the Bush tax cuts expire (those Clinton-era tax rates of 15, 28, 31, 36, and 39.6 percent), and if those rates are raised proportionately (and just a little) to achieve the 3 percent of GDP deficit goal. The marginal rates in that 鈥渂reak tax promise, keep deficit promise鈥� scenario are 15.5, 28.9, 32.0, 37.1, and 40.9. I would argue that this structure of tax rates would be much better for our economy as a whole than the 鈥淥bama dual promise鈥� rates that go up to that Laffer-esque 77 percent at the top and yet are barely lower at the bottom and middle.

So this is just a different argument I鈥檓 making for why the Bush tax cuts should be allowed to expire and why President Obama鈥檚 campaign promise on taxes needs to expire, too.

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