President Obama today is demanding that Congress extend the Bush tax cuts on income under $250,000 for another year. This is being reported as a gambit to “change the subject to the issue of tax fairness.” (See the nearly identical wording in reports by the Associated Press and the New York Times.) Obama’s demand is juxtaposed against the backdrop of a Versailles-like gathering of Mitt Romney donors in the Hamptons, and a coordinated Democratic attack on Romney’s Swiss bank accounts and offshore tax havens, lending the debate a sharp class-warfare flavor.
The Republican outlook on this is that they stand for a rising tide and general growth for all while Democrats mindlessly loot the rich. “I just think if you're lower income — one, you're not as educated, two, they don't understand how it works, they don't understand how the systems work, they don't understand the impact,” complained one put-upon attendee at Romney’s Hamptons soiree. The Wall Street Journal editorial page phrases the same sentiment a bit more delicately, insisting that Obama’s “liberal base has become so obsessed with the politics of envy that it is demanding higher taxes no matter the economic or political costs.”
The question of whether and how we should eat the rich is always fun. But the tax debate isn’t really about whether we should consume the delicious, delicious bodies of the rich, or even whether we should seize their money and give it to the peons. There’s a straightforward macroeconomic debate going on here, and the conservatives do not have the data on their side.
The issue is how to handle the expiration of the Bush tax cuts. The two parties are locked in a fight over the long-term size of government, with Democrats insisting that any long-term fiscal correction has to increase revenues over current levels, and Republicans insisting that revenue remain at current levels. (They’re willing to eliminate some, unspecified tax deductions, but only if all the revenue is plowed back into lower rates.) But when the Bush tax cuts expire at the end of the year, the government will have more revenue than even the Democrats say they want, and the resulting tax hike will threaten the tottering economic recovery. That's part of what everybody is calling the "fiscal cliff."
All sides say they’re concerned about this big sudden tax hike, which a stronger recovery could more easily withstand. Obama’s answer is a one-year extension of the tax cuts on income under $250,000 a year. The GOP’s answer is to extend all the tax cuts.
The economic argument for keeping taxes on the rich low is that they provide rich people with stronger incentives to invest, innovate, and work hard. Whatever the merits of that argument — at current tax levels, I find the argument extremely weak — it has nothing to do with timing: It’s just something you would favor all the time, and indeed, Republicans do favor lower taxes for the rich utterly regardless of economic circumstances.
But the question of the immediate effects of the tax-cut expiration is different. It’s a Keynesian debate about stimulating consumer demand. When the government cuts the deficit in a depressed economy, either by raising taxes or by cutting spending, it lowers people’s spending power. But not all tax hikes are created equal. The poorer somebody is, the more likely they are to spend their money. The evidence here is unambiguous. Raising taxes on the poor and middle class will deliver a huge hit to consumer spending. Raising taxes only on the rich will not.
If Republicans were truly concerned about the state of the recovery, they would agree to extend the parts of the Bush tax cuts that both sides favor, and leave the tax cuts for the rich to be renegotiated next year. Of course, they would never do that, because that would reduce their future negotiating leverage.
Everybody in Washington understands that Republicans will never agree with Obama’s demand. But because everybody understands this, they have internalized the hostage dynamic. That’s why you have lots of centrists and business types saying that Obama should just go ahead and extend all the Bush tax cuts for another year, because otherwise Republicans will just let the whole thing expire. The Republicans' position of holding middle-class tax cuts hostage to preserve the tax cuts for the rich, in addition to lacking economic support, is not popular. Obama’s gambit is to make Republicans pay a price for a taking a stance that’s wildly out of line with public opinion.
Now, I can’t say for sure whether the “nail ladies” who support Obama are basing their position on a firm grasp of Keynesian economic theory. But I can say that the put-upon rich who are convinced they are the engine of the economy are basing their worldview not on economics but on solipsistic self-pity.
Update: In his remarks today, Obama noted that keeping taxes for the middle class low is a far more efficient way to support consumer demand than extending tax cuts for the rich. But the main thrust of his case is the hostage argument. Obama's central argument is simple. Both sides favor, or claim to favor, extending the tax cuts on the bottom 98% of families. They disagree on extending them on the top 2%, and let the election settle the tax cuts for the rich: "We all say that we should extend the tax cuts for 98% of the American people. Let’s agree to do what we agree on.”