Wednesday, August 11, 2010

Read My Lips: Somebody's Taxes Are Going Up

Death and taxes are the only things certain in life once quipped Benjamin Franklin. Were he alive today, he’d also conclude that taxes are certain to be an issue in this fall’s battle for Congress. With the Bush tax cuts expiring this year, there is dispute about what to do. Democrats by and large want to retain tax cuts for those making less than $250,000 a year, while raising taxes on those making more than that. Republicans want to preserve the cuts for all Americans.

The first key issue at hand is what raising taxes on at least some Americans might mean for the economy. The argument that doing so would hurt the economy is simple. The wealthy invest in, and start some businesses. Furthermore, their wealth means that they have the ability to consume a large amount if they so choose. Taking away money for them to invest when the economy is so weak could only hurt businesses already tottering on the edge. That would of course worsen unemployment numbers, and by extension, the entire economy.

There is also an argument to be made that raising taxes on the wealthy might help the economy, though it is somewhat more technical. Yes, you heard that right. First, raising taxes in conjunction with some reductions in long-term entitlement spending and pensions could allay worries that investors have about government debt. The federal government might be ok now, but remember some individual states are really struggling. Many are at risk of losing their AAA credit ratings in the future. Those who do invest will demand a higher interest rate, which will in turn cost state taxpayers more money in the future. Thus, raising taxes as a show of fiscal responsibility could assure that these states have access to credit at a decent rate when they need it.

Second, raising taxes and transferring the money to the middle and working classes would put more money into the pockets of those most likely to spend it, which would boost consumer demand. The wealthy might choose to sit on their money or sock it away in 401ks and IRAs, activities which would stimulate the economy less than direct consumption.

Economists should be engaged in this debate for the foreseeable future. Politically, I’m not sure that running on tax cuts for the wealthy will be a winner at the ballot box for Republicans, since Democrats want to keep cuts for those making less than $250,000. Democratic strategists will surely craft ads alleging that Republicans want to cut the taxes of the same Wall Street CEOs that caused the financial crisis hurting middle America, even as they want to decrease funding on programs like unemployment compensation at a time when so many are worried about the prospect of becoming unemployed or know someone who is.

Besides, not too many people can really relate to the problems of the affluent. Less than 5% of all Americans make more than $250,000 a year. Democrats have effectively neutralized the issue for 95% of the population. And Republicans won’t even win unanimous support among those wealthy whom the cuts would help the most. If I were a Republican strategist, I’d urge the party to focus its energy on criticizing Obama’s handling of the economy instead of fighting for the wealthy.