The Agenda

House Speaker Nancy Pelosi on Taxes and Spending

I’ve tried to draw attention to the way that many Republicans call for tax cuts without calling for commensurate spending decreases. Among Republican congressional candidates, it is now common to hear both a commitment to deep tax cuts as well as to “protecting” Social Security and Medicare from reforms designed to reduce spending, positions that are maddeningly inconsistent. And I’ve addressed the conservative penchant for wishful thinking on how tax cuts impact tax revenues. Arpit Gupta’s recent discussion of the real-world Laffer Curve cited the following:

Uhlig and Trabandt explore this issue further. In particular, they finds that 32% of a labor tax cut, and 51% of a capital tax cut are self-financing, in the sense that lowering those taxes raises economic activity, which itself generates additional taxes, and partially offsets lower tax revenue. [Emphasis added.]

Note the words “partially offsets.” Gerald Prante and Bill Ahern of the Tax Foundation explain why this idea of tax cuts as a free lunch has been a serious setback for advocates of spending cuts:

Republican spokespeople and other tax-cut enthusiasts have asserted that the tax cuts passed in 2001 and 2003 actually increased revenue. They often point to rising revenues from 2004 through 2007 following the tax cuts in May 2003. Unfortunately, as any Economics 101 student will tell you, correlation doesn’t prove causation. Yes, revenue did rise, but we have to answer the question: Would it have risen anyway?

We can never be absolutely sure how the economy would have reacted if the tax cut legislation had failed for some reason in 2001 and 2003, but the consensus among experts is that the economy would have grown in the mid-2000s with or without the Bush tax cuts. That doesn’t mean the tax cuts had no feedback effect at all – people reported more taxable income than they would have — but those beneficial effects were not so great that the tax cuts could have “paid for themselves.”

The most damaging result of this myth is that Republican lawmakers feel less pressure to propose spending cuts. Why bother when cutting a tax rate will raise more revenue?

We do have reason to believe that high-income rate reductions are more likely to spur a long-run increase in taxable income than low-income rate reductions, a subject to which we’ll return in another post. But the central point Prante and Ahern are making is vitally important for conservatives to understand. 

Yet it must also be said that congressional Democrats are also egregious in this regard. House Speaker Nancy Pelosi deserves to be celebrated by progressives who advocate a marked expansion of social expenditures, if not by the rest of us. After Scott Brown’s unexpected victory in Massachusetts, many Democrats saw no choice but to abandon the president’s health reform effort, or at the very least to radically scale back its ambitions. Speaker Pelosi insisted on pressing ahead, and she is thus directly responsible for achieving a goal that the U.S. left has been striving for since the Truman administration. 

And now, according to Jake Sherman of The Politico, she is leaving the door open for preserving the high-income rate reductions first passed in 2001:

The California Democrat, speaking in the same room House Minority Leader John Boehner (R-Ohio) appeared in earlier in the day, said that the “only thing I can tell you is the tax cuts for the middle class will be extended this Congress,” leaving open the possibility that cuts for people making more than $250,000 could be extended at some point, too.

Part of this reflects the fact that, as Sherman explains, 31 House Democrats have pledged their support for extending the high-income rate reductions, at least temporarily. 

Far be it from me to tell Democrats or Republicans how to conduct their affairs, but it seems clear to me that support for increasing taxes ought to be a litmus test for serious progressives. Matt Yglesias made this case in The American Prospect last summer. But while progressives deride those on the political right for their inconsistency, many have failed to reckon with the fact that, as Yglesias explains, new spending initiatives championed by progressives necessitate middle-class tax increases. 

Speaker Pelosi, for all her progressive bona fides, is among those who’ve been blurring the issue. Sherman gives us an indication of her broader worldview:

 

“The tax cuts at the high end have not produced any jobs; it only increased the deficit,” she said. “We’re still paying the price that they have contributed to the deficit all along. I respect that they have a different view, many of these members are members who are budget hawks, so I think we’ll be able to find some common ground on the subject.”

Pelosi, though, made her view clear: Rich people don’t deserve tax cuts. She said she sees “no justification for going into debt to foreign countries to underwrite and subsidize tax cuts for the wealthiest people of America.”

But as Prante and Bill Ahern observe, the debt problem won’t be solved by eliminating the high-income rate reductions alone:

The quickest way to prove this point is to compare the official “score” of the president’s tax proposal — letting the Bush tax cuts expire only for high-income people raises $630 billion over 10 years — with the official score for letting all the tax cuts expire, which raises $3 trillion over 10 years.

That means some pieces did benefit those at the top of the income spectrum: changes to itemized deductions and the estate tax, and the rate cuts on high wages, dividends and capital gains. And measured in nominal dollars, a high-income taxpayer saved more than a low- or middle-income taxpayer.

Nevertheless, the Bush tax cuts sent trillions of dollars in tax relief to those beneath the president’s so-called middle-class cutoff of $200,000, and when the tax cuts are measured as a percentage of their income, or as a percentage of their previous tax payments, the Bush tax cuts provided comparable benefits to all income levels.

The most damaging result of this myth is that Democratic Party spokespeople have convinced much of the electorate that all government funding needs can be solved by just raising taxes on the rich; a dangerous misconception, especially as our nation moves ever closer to a fiscal cliff whose avoidance will require hard choices on spending and taxes that hit all Americans. 

It should also go without saying that allowing all of the tax cuts to expire won’t solve the long-term fiscal imbalance either, though it would make a significant difference by gradually pushing up the tax share of GDP to historically unprecedented levels. As my Economics 21 colleague Christopher Papagianis has explained, the CBO’s extended baseline scenario, in which most of the Bush tax cuts are allowed to expire, sees revenues rising at an impressive clip:

The progressivity of the current tax system means revenue grows faster than the economy over the long term. From 1946-2008, revenues averaged 17.8% of GDP.

Under CBO’s extended baseline scenario, federal tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 (assuming current law remains in place). In other words, if no tax relief is enacted, taxation will increase by more than 30% as a share of the economy (compared to the historical average) in less than 25 years. If you look at the change relative to today’s very low share (14.9%), the jump is more than 50%. 

To be sure, federal tax revenues are unusually low this year due to the weak economy. But a federal tax take of 23.3% is comfortably above the historical norm. It nevertheless is not enough to close the fiscal imbalance that has been exacerbated by recent step increases in social expenditures.

Speaker Pelosi ought to take a page from Ezra Klein’s advice to President Obama:

Why not just level with people? Why can’t Obama just sit down and say,”My friends in the other party want to extend George W. Bush’s tax cuts indefinitely, which will add about $4 trillion to the deficit over the next 10 years. I’d like to extend only tax cuts for every American making less than $250,000. That will add more than $3 trillion to the deficit over the next 10 years. That’s still a lot, but given our economic circumstances, I think it’s worth it. But people may disagree. Another option would be to extend the middle-class tax cuts for three more years, and then let them expire, or phase them out, in order to begin bringing the deficit down. Either way, we should be clear about the choices we’re making here.”

That is, Speaker Pelosi should acknowledge that her favored approach to taxes and spending will lead to an explosion in the level of public debt. Congressional Republicans could in turn concede that they need to craft detailed, credible proposals to lower spending levels, and we could argue about what we consider to be an appropriate long-term spending burden. 

Conveniently, I will address that subject later today!

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