The Wrong Fight on Taxes

The Hill has an article today detailing infighting within the Democrats over what to do with the 2001/2003 tax cuts. The position expressed by President Obama and many Democrats for years has been to extend the tax cuts only for people making less than $250,000, but a growing contingent seems to favor upping that threshold to $1 million, including House Minority Leader Nancy Pelosi (D-CA). Luckily, there has already been some pushback to this idea (see here, here, and here).

The $250,000 definition for the middle class is already higher than it should be, accounting for about 80 percent of the cost of the $4.6 trillion tax cuts. In other words, letting the upper-income tax cuts expire will result in foregone revenue loss of about $900 billion. A rough estimate of moving that threshold from $250,000 to $1 million would result in only about $400 billion of that $900 billion being realized, meaning that about 90 percent of the total costs of extending all the tax cuts would be added to the debt.

It would be bad news for our fiscal situation if the negotiation over the tax cuts will simply be about deficit financing either $4 trillion or $4.6 trillion. Neither party is taking a responsible position on taxes, and it will lead us into trouble. Our fiscal hole is very deep if we extend all the tax cuts, and it wouldn't get much shallower at the $250,000 threshold. At a $1 million threshold, it would barely make a difference.

^{Note: Tax cuts extended below $1M is a rough estimate} 

In addition, the framework of extending tax cuts at a certain income level misses the point. Having distributional goals makes sense, but drawing strict lines in the sand will ultimately do more harm than good. A better focus would be on improving the tax code with an eye towards the distribution and revenue levels that are desired.

The Simpson-Bowles tax reform plan did just that, raising revenue from tax reform while ending up with a more progressive tax code (see here for a distributional table of Simpson-Bowles). It won't be easy to achieve a reform plan that does this, but it would be much more constructive to this kind of debate than to fight about whether we will extend 80 percent, 90 percent, or 100 percent of the tax cuts. We will need to get significant revenue as part of a deficit reduction plan, but the rhetoric from both sides so far is not promising.