By Simon Johnson
President Obama is finally attempting to cut through some of the disinformation and confusion that surrounds US fiscal policy in general and taxes in particular. His suggestion this week is: let’s (effectively) raise taxes on relatively high income people – by letting the Bush tax cuts expire for those people – while introducing temporary tax breaks that will more directly stimulate business investment and presumably hiring.
Any way you cut it, the numbers involved are not big enough to impact unemployment significantly by November, but these ideas – and the Republican rival suggestions currently on the table – are more about symbols, messages, and midterm votes than about accelerating the economic recovery. Seen in those terms, the president is still missing a key argument in both economic and political terms.
The president’s point is simple. If you are arguing to keep the Bush tax breaks for upper income groups in order to support the economy, his proposal represents a direct and reasonable challenge – there are better ways to “use” (i.e., for the government to forgo) tax revenue to help reduce unemployment.
The bigger issue, of course, is the budget deficit and the president feels the need to tread gingerly because the 2010 deficit will come in around $1.3 trillion, according to the Congressional Budget Office, i.e., almost 10 percent of our gross domestic product and over the last two years we have run the highest deficits since World War II.
Everyone agrees that we need to worry about this deficit. The US Treasury can borrow at record low interest rates, but we should not presume this will be the case for the indefinite future. In particular, irrespective of what happens in the United States, our interest rates are determined in part by what developments in the rest of the world – if some subset of Europe, for example, becomes more creditworthy over the next 12-24 months, this will tend to reduce the relative appeal of US government debt to investors (both US and non-US) and likely push up our long-term interest rates – deterring private sector investment and making it more expensive to finance the budget deficit.
Cutting our budget deficit in the short-term would tend to slow the economy and both sides of the aisle are currently treading carefully in this regard. But agreeing to cut the deficit in the future would be helpful and should stimulate the economy – because it would lower long-term interest rates by reducing uncertainty about the trajectory of fiscal policy. This dimension is completely missing from our current political dynamic and from the sensible debate.
The president should be pushing harder for agreement on medium-term deficit reduction, including by putting forward ideas for comprehensive tax reform. The US system has become complex and quite opaque – people have a hard time figuring out what taxes they are pay and what they get in return. Tax systems elsewhere in the industrialized world are just as (or more) progressive while also being more efficient, i.e., cause less distortion in terms of reducing the incentive to work and to invest per dollar of revenue collected.
In the context of redesigning the tax system to promote employment and responsible savings, it is entirely appropriate to look for ways to shift the burden of taxation back to relatively high income individuals. This group has had a great run over the past 30 years – while the consequences for most Americans, as seen for example in real median wages (flat), the stability of employment (look around you), or the vulnerability to financial crisis (2008-09 was a wake-up call), have been much less favorable.
The president’s latest proposals are tinkering at the margins and will likely only have a limited impact. But if the president moves the broader debate towards considering fair, reasonable, and efficient ways to tax higher income individuals, this is a step in the right direction.
As prepared for submission to the NYT.com’s Economix and used here with permission. If you would like to reproduce the entire post, please contact the New York Times.