December 3, 2011
Thorndike: The Tragic Death of the Temporary Tax Cut
[E]xtending the payroll tax cut will continue a disturbing trend in American politics: the gradual demise of the temporary tax cut.
Once upon a time, politicians took it for granted that taxes should go up and down over the course of the business cycle. Economists call this demand management (while the rest of us call it Keynesianism, after its most famous advocate, British economist John Maynard Keynes). The basic concept is simple: Cut taxes during recessions to encourage consumer spending, then raise them during booms to keep inflation at bay. (Demand can be managed through government spending, too, but let’s focus on the tax system for now.) ...
Lawmakers have been less diligent about raising taxes to cool an overheated economy. Still, they’ve made the occasional stab at it. During the Vietnam War, Congress imposed a special 10% income tax surcharge to slow inflation. Similarly, debt worries in the economically vibrant 1990s prompted Congress to roll back some of the tax cuts enacted under President Ronald Reagan. ... By contrast, today’s politicians lack the stomach for well-practiced Keynesianism. They are still enthusiastic about cutting taxes to spur recovery. But they’re increasingly unwilling to let “temporary” tax cuts expire....
The demise of truly temporary tax cuts is no big deal – assuming you don’t plan to use tax-based stimulus as a tool for fighting recessions. But demand management requires revenue flexibility. If tax policy only goes one way – down – then we won’t have the tools we need to keep the economy healthy.
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