Legal Commentary

Why Middle Class Tax Cuts?

By Big Tent Democrat

Paul Krugman writes:

[B]ack in 2001, the Bush administration bundled huge tax cuts for wealthy Americans with much smaller tax cuts for the middle class, then pretended that it was mainly offering tax breaks to ordinary families. Meanwhile, it circumvented Senate rules intended to prevent irresponsible fiscal actions — rules that would have forced it to find spending cuts to offset its $1.3 trillion tax cut — by putting an expiration date of Dec. 31, 2010, on the whole bill. And the witching hour is now upon us. [. . .]

In response, President Obama is proposing legislation that would keep tax rates essentially unchanged for 98 percent of Americans but allow rates on the richest 2 percent to rise. But Republicans are threatening to block that legislation, effectively raising taxes on the middle class, unless they get tax breaks for their wealthy friends.

I think that is an accurate description of the state of play. But what is the policy rationale for tax cuts for the middle class? Krugman argues:

Almost everyone agrees that raising taxes on the middle class in the middle of an economic slump is a bad idea, unless the effects are offset by other job-creation programs — and Republicans are blocking those, too. So the G.O.P. is, in effect, threatening to plunge the U.S. economy back into recession unless Democrats pay up.

This argument is rooted in the belief that, unlike the wealthy, who will save most of their tax relief, the middle class will spend (indeed have to spend), thus giving middle class tax cuts a stimulus force that tax cuts for the wealthy simply does not have. A Moody's study supports this argument:

Give the wealthiest Americans a tax cut and history suggests they will save the money rather than spend it. Tax cuts in 2001 and 2003 under President George W. Bush were followed by increases in the saving rate among the rich, according to data from Moody’s Analytics Inc. When taxes were raised under Bill Clinton, the saving rate fell.

The findings may weaken arguments by Republicans and some Democrats in Congress who say allowing the Bush-era tax cuts for the wealthiest Americans to lapse will prompt them to reduce their spending, harming the economy. President Barack Obama wants to extend the cuts for individuals earning less than $200,000 and couples earning less than $250,000 while ending them for those who earn more.

“I would tend to wonder how much the tax cut actually influences spending behavior,” said Chris Cornell, an economist who mined government reports back to 1989 for West Chester, Pennsylvania-based Moody’s Analytics. “Spending by the top 5 percent of households seems much more closely tied to business- cycle issues than it does to tax-cut issues.”

This finding also converges with common sense. There simply is no good economic reason (indeed, there was no good reason in 2001) to provide tax cuts for the wealthy. There were political reasons of course. But now the politics seems clear -- not giving tax cuts to the rich is the politically smart move. Good policy and good politics. Dems need to stand strong, as the President has.

Speaking for me only

Full post as published by TalkLeft on September 17, 2010 (boomark / email).