The Economy is Finally Showing Signs of Life: Don't Sabotage it!

Finally, the economy is showing strong signs that the six-year slump may be coming to an end.   236,000 people found work in February, far more than economists had expected, and the unemployment rate is 7.7%, the lowest level in four years.

Rising house prices and a booming stock market are driving up household net worth, which should boost spending.  The housing sector is  rebounding.  Corporations are sitting on a huge pile of cash, which means that there’s lots of room for investment and hiring once businesses are convinced that the recovery is for real.

With all this good news, why would Washington want to throw sand in the gears of the economy?  But it is, big time.

The deal to avert the fiscal cliff let payroll taxes rise by 2 percentage points, which cut household after-tax incomes and is depressing consumer spending.  The insane sequester will hurt the economy by reducing federal workers’ pay  and reducing employment as federal hiring comes to a standstill and contractors have to lay off workers (or cancel hiring plans).

There is a time to cut government spending, but it’s not now.

There is, however, a potential bipartisan path out of this morass. Republicans and Democrats are each right about some big things that seem to divide them.  Democrats are right that taxes will need to increase.  The retirement of the baby boomers means that there will be unprecedented demands on government.  The tax level that sort of worked for the past 30 years won’t be adequate to pay the Social Security, Medicare, and Medicaid (which covers half of nursing home care) that we’ve promised baby boomers, even under the most optimistic assumptions about cost controls.  And Republicans are right that we must slow the out-of-control growth of entitlement spending–especially for government healthcare programs.

The President has signaled willingness to take on entitlement reform, over objections of some of his caucus.  He should be able to win over a substantial number of Democrats with a simple argument:  if we do not control health care spending, it will crowd out everything else that government does.

The GOP has  dug their heels on additional tax revenues, but tax reform that curtailed tax expenditures, cut tax rates, and raised net revenues still seems like a possibility.  Republicans really should favor this.  Spending programs administered by the IRS do as much to increase the size and scope of government as direct spending programs, and deserve the same level of scrutiny.

Serious tax reform would take a couple of years, but that is a plus.  If the economy keeps recovering, modest revenue  increases starting in 2015 would be well timed.  Similarly, the effects of serious entitlement reform would take many years to have much effect on the budget, but they will solve the real budget problem, which is long term (and won’t hamper the economic recovery).

Congress should cancel the irrational sequester and instead enact policies that could help speed up the recovery.  Congress and the President should agree to pair tax reform with entitlement reform and get down to work on both.

Or law makers can  continue to sabotage the economy and hope the other side gets blamed for the resulting economic carnage.

I know the smart money is on the latter outcome, but I’m hoping that for once smart policy will prevail.

Len Burman is coauthor with Joel Slemrod of Taxes in America:  What Everyone Needs to Know.

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Obama is Again Backed into Corner on Tax Cuts

President Obama has proposed to extend the middle class "Bush era" tax cuts for another year.  My first reaction was "Wow, that's a big surprise." (That was sarcasm.) My second was that the euphemistic "Bush era" sounds like a time when humans were wandering around in loin cloths seeking shelter in caves and under shrubs.

As part of my ongoing series, "I told you so!", I'll point out that the current impasse was completely foreseeable when President Obama and Congressional Republicans agreed to a "temporary" two-year extension of the expiring Bush tax cuts in 2010.  The following is from "Will Dems fall for temporary tax cut gambit (again)?", which I published on December 8, 2010.

In the short term, there's a certain logic to giving in. Yes, passage of the middle class tax cuts and extended unemployment benefits won't happen without Republican support. Yes, the Democrats will be even less able to control the political agenda when the Republicans take control of the House in January [2011]. And, yes, letting all the tax cuts lapse would hurt the fragile economy.

But in the long term, the consequences of the "deal" could be devastating. Here's my nightmare scenario:

Think ahead two moves, to 2012, when this temporary deal expires. Many forecasters think the economy will still be fragile, so you can expect Republicans to argue that it is no time to raise taxes. 

And it's very possible if the economy remains weak and/or Obama doesn't find his mojo, that there will be a Republican president and a Republican senate. 

At that point, Republicans might well not agree to another temporary extension of the tax rates. Instead, they'll wait until they control government to introduce HR1 in the 2013 Congress -- a permanent extension of the Bush tax cuts that the new president will sign triumphantly.

That is exactly where we are today.  The president has proposed a one-year extension of the middle class tax cuts, which he defines as incomes under $250,000.  The Democrats in Congress apparently would like to ratchet up middle class to include everyone earning under $1 million.  The Republicans are insisting that all the Bush tax cuts be extended permanently.  And, by the way, we are several trillion dollars closer to insolvency than we were in 2010 and the economic recovery seems hardly more secure than it was then.

Since the economy is weak, the Republicans have a plausible argument against tax increases and a decent chance of regaining the White House so they won't compromise.

This plays nicely into the Democratic narrative that Republicans only care about rich people and the Republican narrative that Democrats want to raise taxes.  It's a very tiring and unenlightening debate.

Obama's original sin was never seriously proposing a tax reform plan.  Replacing the Bush Tax Cuts with Bush Tax Cuts Lite is just bad policy.  Over the long term, we simply can't afford even the middle class part of the Bush tax cuts, and the tax code is unfair, inefficient, and incomprehensible.  It badly needs an overhaul.

The president has talked a lot about tax reform--he asked Paul Volcker to put together a plan (which was more of a set of guidelines than actual legislation) and his debt reduction commission  proposed eliminating most tax breaks and cutting tax rates.  Volcker's plan went into the same impregnable file drawer as President Bush's tax reform panel report. President Obama said that the Bowles-Simpson proposal had "made important progress" on tax reform, but apparently not enough to prompt an actual presidential proposal.

The president has also proposed corporate tax reform, which isn't a bad idea, and the "Buffett Rule," which is, but nothing resembling comprehensive individual income tax reform, or even a coherent alternative to the Bush tax plan.

So we'll dance to the edge of the fiscal cliff and, more likely than not, we'll temporarily extend all the Bush tax cuts after the election.  Even if Mr. Romney wins, I wouldn't be surprised if the extension is only temporary.  Getting to play the Democrats for suckers every year or two must be a lot of fun--and a great source of campaign contributions--for the GOP.

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