Sunday, December 5, 2010

Senate Republicans Fall For Tax Cut Trap

Senate Republicans have followed their House colleagues into the trap of voting against extension of the Bush tax cuts for the middle class. Senate Democrats offered extension of the tax cuts for annual income of $1,000,000 or less. Republicans are holding out for extension of the tax cuts at all income levels, including annual incomes above $1,000,000. House Democrats previously voted to extend the tax cuts for annual income of $250,000 or less.

The trap is that the tax cuts enacted during the Bush years are set to expire at the end of 2010. Democrats can now argue that they have voted to extend the tax cuts for most Americans, but were blocked by Republicans voting No.

On the other side, the Democrats now have their votes on record to extend the tax cuts for the middle class. So they could sit tight and not budge, calling the Republican bluff. But there are other things they want, such as extension of unemployment benefits, that they can't get without acquiescence of the Republicans.

There is much talk in Washington of a compromise to extend the tax cuts temporarily for two years But they don't have a compromise deal done yet.

In the meantime, the problem of getting the federal deficits under control continues to mushroom. The Bowles-Simpson deficit commission has come forth with a plan to slash income tax rates but also take away many deductions (lower tax rates on a higher tax base). The net result would substantially increase total federal tax revenue levels. The deficit commission also wants to cut total federal spending levels.

Republicans and Democrats don't like the sound of the deficit commission plan even though that is what is needed to get the deficits under control. So you can see where this is going. Any compromise on the tax cut extension will likely put off deficit reduction for a couple of more years.

In the floor debate, Iowa Republican Senator Charles Grassley laid out the rationale for not looking to tax revenues for deficit reduction: "The taxpayers are smarter than we in Congress are. They know that if they give another dollar to us to spend it's a license to spend $1.15."

That strategy of passing tax cuts to starve the government of revenue and contain spending has been Republican Party dogma since Ronald Reagan was elected in 1980. The problem is that it lacks an end game. A 15 cent deficit may not seem like much, but after 7 years that adds $1.05 in debt, a whole year's worth of spending. After 30 years, that's $4.50 in debt.

You see, it's too easy for politicians to cut taxes and borrow money so they don't have to cut spending. Then everyone seems to get what they want for now. It's the old Keynesian trick. It works in the short term, and in the long term we're all dead. It ended badly when Ronald Reagan tried it in the 1980s. It ended badly again when George W. Bush tried it in the 2000s. It will end badly if we try it again. The Republican strategy is, in a word, insane.

I'd like to suggest a new strategy. Set the tax rates at the level needed to equal federal spending. If those rates are too high, that will create the political pressure to reduce spending so that the tax rates can be reduced. And in the meantime we aren't running up a huge debt. I have a great new term for this strategy - I call it a "balanced budget."

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