Different Opinions on the Tax Compromise

I’ve been watching the negotiations on extending the Bush tax cuts take shape, and in the compromise shaping up between President Obama and the Republicans in Congress, nobody will get exactly what they want.

But, I was surprised to read Fareed Zakaria’s assessment in the Washington Post, because I think of him as a smart guy, and his opinion on the compromise is exactly the opposite of mine.  He says, “The only parts of the plan likely to have a significant effect in stimulating the economy are the extensions of unemployment insurance, cuts in payroll taxes and, perhaps, tax credits for businesses (“perhaps” because they are temporary and thus would only bring forward investments). To get these measures, worth about $250 billion, Obama agreed to an extension of the Bush tax cuts that will cost around $750 billion…”

So, Zakaria’s opinion is: Extending unemployment insurance: Good; Cuts in payroll taxes: Good; Extension of the Bush tax cuts: Bad.

My opinion is exactly the opposite: Extending unemployment insurance: Bad; Cuts in payroll taxes: Bad; Extension of the Bush tax cuts: Good.

I do have some sympathy for people who have a difficult time finding a job in a stagnant economy, but when you pay people to be unemployed, you are going to get more unemployed people.  Extending the unemployment benefits will slow the recovery (it already has), and contribute to the very problem it is supposed to mitigate. Unemployment would be lower, and the economy would recover faster, if we did away with the extended benefits.

I am also amazed that President Obama and other Democrats want to extend them, because the sagging economy works against Democrats.  Politically, it makes no sense for President Obama to bargain for a policy that will reduce his re-election chances in 2012.  So, extending unemployment insurance is bad for the economy, it’s bad for the Democrats, but it’s good for the Republicans.

A one-year cut in payroll taxes makes no sense to me.  I’m generally in favor of tax cuts, but with the (mythical) social security trust fund running down, why implement a tax cut that further compromises the program’s finances?  Zakaria seems to think this will stimulate hiring, but would employers really want to hire more now just because they get a one-year discount on labor costs?  Temporary tax cuts have a minimal stimulus effect, because everyone knows they will go away.  Zakaria even seems to acknowledge this when he mentions temporary tax credits for businesses.  Does the same argument not apply to a temporary payroll tax cut?  No stimulus effect, plus further weakening social security: those are the reasons I put this in the bad column.  But I would not call this “really bad,” because it is, after all, a tax cut.

Which brings us to the extension of the Bush tax cuts.  Lowering marginal tax rates is the best way to use tax policy to boost economic activity.  That’s what the Bush tax cuts did, and that’s why we should not only extend them, but make them “permanent” (of course, nothing in politics is really permanent).

President Obama seems to have no awareness that people who make high incomes make those incomes by (1) working hard, and (2) taking risks.  When the government shares in your profits, but not in your losses, that creates a disincentive toward risk-taking (and working hard), which reduces entrepreneurial activity in the economy: activity that keeps the US economy moving ahead.  For that reason, extending the Bush tax cuts for high-income people is more important to economic progress in the US than extending them to lower-income people.

I felt that my views on the tax compromise were straightforward enough that there was almost no point in mentioning them.  But when I saw that Fareed Zakaria’s views were exactly the opposite of mine, that prompted me to speak up.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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