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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Is Buffett Rule a First Step Towards Tax Reform?

When the president first announced his Buffett Rule--that millionaires should pay at least 30 percent of their income in tax--in the State of the Union address in January, I had a strong sense of déjà vu.  It is another alternative minimum tax, and its provenance is very similar.  Congress created a minimum tax back in 1969 when people were up in arms about 155 high-income people who hadn't paid tax a few years earlier.  The logical response would have been to close the loopholes that let rich people avoid tax, but that would have been politically costly, so instead we got the thing that evolved into the AMT--one reason  millions of upper middle-class Americans hate tax day.

The new AMT, called the Fair Share Tax, is anathema to tax reform (and I opined on that in today's New York Times). It will be one more complication for people who are affected.  For example, if you're on the cusp of paying FST, you won't know whether your capital gains will be taxes at 15 or 30 percent. And it will generate enormous marriage penalties.

And it's unnecessary.  If Congress is not willing to fix the underlying defects in the tax code, they don't need a new AMT. One is really enough.  If capital gains and dividends were fully taxed under the AMT, as they used to be before the Tax Reform Act of 1986, the Buffett Rule would be satisfied without a new levy.  Moreover, I suspect that would raise enough more revenue that Congress could use  the savings to finally index the thresholds for the AMT so that it doesn't have to be patched every year.

Some people, however, see the Fair Share Tax as a good start on tax reform.  The Times also has a nice article about two economic rock stars, Emanuel Saez and Thomas Picketty, who have been extremely effective at putting together data and analysis on rising economic inequality. The article is titled, "For Two Economists, the Buffett Rule Is Just a Start," so the question is whether the Buffett Rule is a first step towards tax reform and a fairer, more progressive tax system, or a dead end.

The president has said that the Buffett Rule is not a specific proposal, but a principle for tax reform. The actual specific proposal, the Fair Share Tax, which the president supports, includes language saying that tax reform is the goal (thanks David desJardins for reminding me of this):

It is the sense of the Senate that--
(1) Congress should enact tax reform that repeals unfair and unnecessary tax loopholes and expenditures, simplifies the system for millions of taxpayers and businesses (including by eliminating the alternative minimum tax for middle-class Americans), and makes sure that the wealthiest taxpayers pay a fair share; and
(2) this Act is an interim step that can be done quickly and serve as a floor on taxes for the highest-income taxpayers, cut the deficit by billions of dollars a year, and help encourage more fundamental reform of the tax system.

The question is whether the Fair Share Tax is a complement to tax reform, or a substitute.  The president has been talking about individual income tax reform for several years. The president commissioned Paul Volcker to put together a tax reform plan, which issued a report that went nowhere. The president said that his Bowles-Simpson commission, which would have simplified taxes (although not made them markedly more progressive), had a lot of good ideas, but none of those ideas actually made it into his budget. President Bush actually did commission a credible tax reform plan, but once completed, he acted like it was never his idea.

If the president and Congressional leaders really want tax reform, they should propose tax reform and throw their weight behind it.  I understand this might not be a winning strategy in an election year, but we could lay the groundwork by putting together a serious proposal. President Reagan commissioned his Treasury to quietly put together a tax reform plan behind closed doors during the 1984 election year and then he pushed it to passage in 1986.

I don't, however, think it's in Democrats' long-term interest to further undermine an already dysfunctional tax system. The Fair Share Tax might be good politics, but it's bad policy.

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