Thursday, December 30, 2010
It is nevertheless possible to defend the new Act on two grounds. The first, and I think less important, is that it indicates the possibility of compromise between the Obama Administration and the resurgent, and increasingly conservative and assertive, Republican Party, though compromise will be more difficult come January when the Republicans take control of the House of Representatives and significantly increase their representation in the Senate. Second, and more important, estimates that GDP would grow by at least 3 percent in 2011 were premised on the expectation that the bulk, at least, of the Bush tax cuts would be continued. Given the weakness of the economy, a sudden tax increase in 2011, which would have been the effect of allowing those cuts to expire, could easily have knocked one or two percentage points off the GDP growth rate.
It would have been better to have just continued the tax breaks and not have cut the payroll tax and extended unemployment benefits. A small, and possibly (though not probably) temporary, tax cut is unlikely to stimulate much spending, and extending unemployment benefits can actually increase unemployment by making unemployed workers more picky in their search for a new job. These provisions of the Act are simply the Democratic quid pro quo for the tax breaks for the wealthy, favored by the Republicans.
Both supporters and opponents of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 usually confuse its short term-stimulus effects on the economy, and its long-term effects on economic growth. I would give it a grade of C+ as a short-term stimulus to the economy, and a grade of B+ for its effects on longer-term growth.
The Act provides for a one-year two-percentage point reduction in employee contributions to social security taxes at an estimated cost in tax revenue of over $100 billion. This will add a significant amount to the budgetary deficit for the year going forward, while providing very little short-term stimulus. Even the most simplistic Keynesian analysis recognizes that a one-year tax reduction will be mainly saved in order to spread out the added consumption from this additional “wealth” of households over more than a single year. In economics terminology, a one-year tax relief would be considered a transitory increase in income rather than a permanent increase. ...
The largest component of this Tax Relief Act is the extension of the Bush-era tax cuts on incomes, dividends, capital gains, and estates. This extension will have some relatively short-term benefits to the economy by stimulating investments and the formation and expansion of small businesses, but the main case for extending these tax cuts is their effects on longer-term economic growth. The growth rate in per capita incomes is determined mainly by the rates of investments in human and physical capital, and by technological progress. Both these drivers of economic growth are in good part in turn determined by tax rates on personal and business incomes.
I view the maintenance of the Bush tax cuts as only the first important move of the American tax code toward a more effective income tax structure. That structure would have a broad-based low rate flat tax on personal incomes, with little, if any, taxation of corporate incomes, and with dividends and capital gains taxed as ordinary income. As the majority report of the recent National Commission on Fiscal Responsibility and Reform proposed, the income base should be greatly broadened by eliminating the deductibility of interest on mortgages, and a variety of other special deductions that result from the political influence of various special interests. ...
A broad-based flat income tax could have a relatively modest tax rate- perhaps about 25%- and still raise as much revenue as the tax structure that would exist if the Bush tax cuts were allow to lapse. A flat consumption tax would be even better than a flat income tax since such a consumption tax would not distort the incentive to save. However, this type of consumption tax is unlikely to be introduced as a substitute for the income tax. It could play a role as a supplement to the income tax if that combination were necessary to prevent a narrow-based progressive income tax system from being imposed.