Concerned about both the weak economy and its political consequences for the Administration, the President and his advisors would like to enact more fiscal stimulus. Yet they know they cannot get the votes to increase spending. Congressional Republicans are unified against deficit-increasing spending for any goal. Enough Congressional Democrats have joined them that the President’s first choice is impossible. The supposed policy positions look like this.
Do you support fiscal stimulus?
|through spending increases yes||through spending increases no|
|through tax cuts yes||1||2|
|through tax cuts no||3 – The President
& Congressional Democrats
|4 – Congressional Republicans
& a few Democrats
The intellectually pure fiscal stimulus positions are boxes 1 and 4.
The President and most Congressional Democrats are in box 3. They support fiscal stimulus but only in the form of increases in government spending. We saw this when the House recently passed a bill in which Blue Dogs insisted that any tax cuts be offset by other tax increases, but were quite comfortable using a fiscal stimulus argument to justify increased government spending that increased the deficit.
While Congressional Republicans claim they are in box 4, I believe most of them would actually be in box 2 if presented with the opportunity. They would be happy to support short-term fiscal stimulus if it were implemented in the form of tax cuts, and they are using anti-fiscal stimulus arguments as a way to argue against the only stimulus likely to be enacted, through increased government spending.
While the Administration and its allies try to enact spending increases, under current law taxes are scheduled to increase effective January 1 of next year:
- the individual income tax rates will increase from 10/15/25/28/33/35 to 15/28/31/36/39.6;
- the per-child tax credit will decrease from $1,000 to $500;
- capital gains tax rates will increase from 5/15 to 10/20;
- dividends will be taxed as ordinary income, rather than at 5/15 percent rates; and
- the estate tax will return to life, with a $1 million exemption and a 60 percent top rate.
CBO estimates these tax increases will increase federal revenues and reduce the budget deficit by about $170 B in 2011. If you are a big believer in fiscal stimulus that is a huge contraction. That amount is bigger than the deficit increase in that year resulting from the President’s Feb 2009 stimulus law.
The President and his Congressional allies propose to allow only the “taxes on the rich” to increase. From the above list they would allow the 33% and 35% individual income tax rates to increase to 36% and 39.6%. They would allow the capital gains and dividends tax rates to increase and maybe create a tiered structure so that higher rates apply only to those with higher incomes. And they would allow the estate tax to return, albeit with a larger exemption and a lower rate. These are longstanding Presidential commitments and now qualify as Democratic party dogma.
They are also anti-stimulus. A better word might be “contractionary.” The Administration says their policies would raise taxes on the rich and reduce deficits by about $45 B in 2011. That is almost 50% larger than the deficit effect of the pending proposal to extend unemployment insurance benefits.
While these tax increases would reduce the deficit, they have negative economic effects as well:
- Any tax increase leaves less money in the hands of private individuals and firms to do with as they see fit.
- The top marginal income tax rates apply not just to rich individuals and families but also to successful small businesses. The President and his allies are proposing higher taxes on small businesses in a weak economic recovery. That is bad policy and terrible politics.
- Uncertainty about future tax rate increases is a factor in firms hoarding cash. We need firms to hire workers and increase investment.
- Lowering the dividend tax rate in 2003 reduced the tax incentive for corporations to hoard cash. Dividend payouts increased. Allowing dividend tax rates to increase will encourage corporations to hoard even more cash than they are now.
The President could trap Republicans in their own anti-fiscal stimulus rhetoric by proposing to extend all the Bush tax cuts for, say, two years along with extending unemployment insurance. I believe Congressional Republicans would quickly shift from box 4 to box 2 above. Both Congressional parties would be exposed for their intellectual inconsistency on fiscal stimulus while they enacted a bipartisan law.
Let’s look at the benefits of this:
- If you’re a believer in fiscal stimulus, then this is additional stimulus that you can enact now. It’s not big, but when combined with an extension of unemployment insurance it’s almost $80 B over the next year. That is still only about half a percent of GDP, but it’s the best they can get out of this Congress, and the tax cuts would have an effect immediately as uncertainty is eliminated and expectations change.
- This policy would help small businesses and eliminate tax uncertainty for all businesses for two years.
- Keeping the dividends rate low would eliminate the added incentive for corporations to hoard cash that will occur next year if the President’s policy is enacted.
- The President could demonstrate that he can be bipartisan.
- By enacting it for two years he can once again tee up “tax cuts for the rich” as a political issue in election year 2012.
This would create the same legislative coalition that enacted the 2008 stimulus negotiated by Speaker Pelosi, Leader Boehner, and then-Secretary Hank Paulson after President Bush proposed it. With Presidential leadership such a coalition could be rebuilt today.
The idea is not without costs for the President:
- Spending-side stimulus advocates will correctly point out that some of the tax relief would be saved rather than spent. They will forget to mention that the stimulative bang from tax relief will occur immediately, while government spending has its effect slowly.
- The President would have to temporarily reverse himself on a core element of his economic policy. It would also undercut his “blame Bush” message.
- Even when combined with an extension of unemployment insurance benefits, the stimulative bang is smaller than someone like Dr. Krugman would argue is needed.
- This move would split Congressional Democrats, many of whom could not imagine voting either for the policy or to extend President Bush’s legacy.
- It would similarly anger many in the Democratic political base, upon whom Congressional Democrats are depending to prevent a rout this November.
For the above reasons this idea won’t happen, but I think it is a useful thought experiment to illuminate the intellectual inconsistency on both sides of the fiscal stimulus debate. On this I agree with Megan McArdle:
Wading through the online debates, I note that opinions on stimulus are nearly 100% correlated with the composition of that stimulus, and the opinionator’s prior view of that activity. So when Democrats are in power and stimulus is mostly spending, liberals think that the stimulus is an issue of fierce moral urgency stymied by venal greed and rank idiocy, while conservatives develop deep qualms about budget deficits. When Republicans are in power, and stimulus consists mostly of tax cuts, Democrats get all vaporish about deficits and the income deficit, while Republicans suddenly realize that the normal rules don’t apply in an emergency. When out of power, both sides will grudgingly concede that some small amount of highly temporary stimulus might be all right, but note (correctly) that the other side seems to be trying to make permanent as much of this “stimulus” as possible.
For me, then, this mostly ends up as a proxy war over the level of government spending, a war I’d rather fight honestly on value grounds rather than attempting to disguise my preferences with a shoddy veneer of “scientific” logic.
As President Obama ramps up his partisan campaign blame rhetoric, remember that he is choosing not to pursue this bipartisan option that would enact more fiscal stimulus and extend unemployment insurance benefits while preventing tax increases on small business owners during a too-slow economic recovery.
(photo credit: fazen)