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Rosalind Helderman of the Washington Post reports in Saturday’s paper that a “Faint rift opens in GOP over tax pledge”–referring to the pledge that Americans for Tax Reform’s Grover Norquist has compelled virtually all Republican policymakers to sign.  Helderman explains how the ground seems to be shifting:

In GOP activist circles it is known simply as “the pledge,” and over the past generation it has become the essential conservative credential for Republicans seeking elective office. Of the 242 Republicans in the House today, all but six have signed the pledge.

But now, an increasing number of GOP candidates for Congress are declining to sign the promise to oppose any tax increase, a small sign that could signal a big shift in Republican politics on taxes.

Of the 25 candidates this year promoted by the National Republican Congressional Committee as “Young Guns” and “Contenders” — the top rungs of a program that highlights promising candidates who are challenging Democrats or running in open seats — at least a third have indicated they do not plan to sign the pledge authored by anti-tax crusader Grover Norquist.

Why the change in heart?  For one reason, because the lopsided, no new revenues (not just no new higher tax rates) stance just doesn’t make policy sense to many of these Republicans, who can’t see how spending-side-only approaches are easier than approaches involving a mix of spending cuts and revenue increases:

Republican candidates declining to sign generally indicate that they nevertheless oppose tax hikes. But some chafe against the constraint on eliminating tax loopholes, believing those restrictions limit Republicans’ ability to negotiate seriously with Democrats on a deal to tackle the nation’s mounting debt.

In Pennsylvania, Republican state Rep. Scott Perry said he was disappointed to see his party’s presidential candidates — all but one of whom signed the pledge — uniformly indicate in a debate last year that they would reject a deficit reduction deal that paired $1 in revenue increases for every $10 in spending cuts.

“I just think it’s imprudent to hem yourself in where you can’t make a good agreement that overall supports the things you want to do,” said Perry, who said he generally opposes tax increases but recently won a Republican primary in a conservative district over candidates who had signed the pledge. “I just don’t see what the point of signing would be for me. .?.?. I’ve got a record, and everyone who wants to know where I’ve been and where I’m at can look to that.”…

“I don’t want to get tied up in knots,” said Richard Tisei, an NRCC Young Gun and former Republican state senator in Massachusetts who is running against Democratic Rep. John F. Tierney. “If there’s a loophole that can be closed that ends up generating additional revenue that can be used specifically to pay down the national debt, I’m not going to lose sleep. And I don’t want to be bound by the pledge not to close it.”

The refusals among some new candidates come as a handful of incumbent Republicans who signed the pledge when they first ran for office also are publicly rejecting it.

Freshman Rep. Scott Rigell (R-Va.), who signed the pledge in 2010, recently posted an open letter to constituents indicating that he would not renew the promise as he runs for reelection. He said he fears it could stand in the way of an everything-on-the-table approach to tackling the mounting debt.

“Averting bankruptcy requires us to grasp the severity of our fiscal condition and summon the courage to speak boldly about the difficult steps needed to increase revenues and sharply decrease spending,” he wrote.

For another reason, it seems that voters don’t find a candidate’s blind allegiance to one man’s idea of the best fiscal policy very attractive:

[A]fter months of Democratic attacks on ATR and Norquist as obstacles to a debt deal, some Republican candidates report that they are hearing from more voters who want them to reject the pledge than the opposite.

Gary DeLong, a member of the Long Beach City Council who is labeled a “contender” for a House seat by the NRCC, said he is routinely encouraged on doorsteps and at town halls and candidate coffees to avoid the pledge.

Voters “ want me to represent them and not special interests,” said DeLong, who will compete next month in California’s unusual mixed-party primary for one of two spots on the November ballot in a newly drawn district.

What is it that has kept so many Republican policymakers so enthralled with Norquist, despite all the evidence to the contrary that “no new taxes” just makes no sense–and (perhaps the most puzzling part) despite Norquist’s lack of charisma?  Senator Coburn has certainly been working to get his colleagues to snap out of the Norquist trance; the Post article concludes with this:

Sen. Tom Coburn (R-Okla.), a fiscal conservative who has tangled with Norquist, said he believes candidates are starting to understand that the ATR pledge’s power has been exaggerated by Norquist and the media and that Norquist is wrong when he asserts that it is nearly impossible to win a Republican primary without signing the pledge.

“That’s him patting himself on the back,” Coburn said. “And I think it’s bull crap.”

[UPDATE 3 pm Sunday:] And this just out from another Republican who’s even more fed up than Coburn about Norquist… Former Senator and co-chair of President Obama’s fiscal commission, Alan Simpson, had this to say today on CNN’s Fareed Zakaria GPS (as reported on Talking Points Memo):

“For heaven’s sake, you have Grover Norquist wandering the earth in his white robes saying that if you raise taxes one penny, he’ll defeat you,” [Simpson] added. “He can’t murder you. He can’t burn your house. The only thing he can do to you, as an elected official, is defeat you for reelection. And if that means more to you than your country when we need patriots to come out in a situation when we’re in extremity, you shouldn’t even be in Congress.”

The Congressional Budget Office has just released an excellent analysis prepared by CBO economist Ben Page on the “Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013″ (in typically dry CBO-speak).  I prefer to think of it as an economics version of the story “The Little Engine That Could.”  You see, the “engine” is the U.S. economy, and this so-called “fiscal cliff” is, rather than something we are in danger of falling off of, something we are about to ram straight into–like a huge wall just ahead on the tracks, at January 2013.  When economists and policymakers fret about this fiscal cliff, it’s not the usual worrying about the unsustainable deficits we are projected to run over the next several decades; it’s concern that our economy, still in “recovery,” can’t handle the amount of deficit reduction that is scheduled to be forced upon us in just a matter of months.

The CBO analysis validates this worry, first defining the scale of the cliff as $607 billion worth of deficit reduction in one year (or $560 billion net of economic feedback, cutting the deficit nearly in half between fiscal years 2012 and 2013), then explaining that letting our economy run head onto this cliff will in fact, slow it down and perhaps even cause the “double-dip recession” economists have been fearing.  From the summary (emphasis added):

Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects—with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.

So CBO then looks at the question: what if we could avoid the cliff entirely–by sort of going around it?  Well, going around it would indeed keep us going in 2013:

CBO analyzed what would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013. In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law.

So that sounds, good: if we can’t go through the fiscal cliff, just go around it (or just say “poof” and imagine it away).  OK, I’ll take that ticket… Except, as CBO next explains, then the inevitable (real) “cliffs” ahead just get taller and steeper:

However, eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years would reduce output and income in the longer run relative to what would occur if the scheduled fiscal restraint remained in place. If all current policies were extended for a prolonged period, federal debt held by the public—currently about 70 percent of GDP, its highest mark since 1950—would continue to rise much faster than GDP.

Such a path for federal debt could not be sustained indefinitely, and policy changes would be required at some point. The more that debt increased before policies were changed, the greater would be the negative consequences—for the nation’s future output and income, for the burden imposed by interest payments on the federal debt, for policymakers’ ability to use tax and spending policies to respond to unexpected challenges, and for the likelihood of a sudden fiscal crisis. And the longer the necessary adjustments in policies were delayed, the more uncertain individuals and businesses would be about future government policies, and the more drastic the ultimate changes in policy would need to be.

You see, even over the longer term, the “fiscal cliff” is more like one we will have to climb rather than one we’re in danger of falling off of.  And the higher the cliff gets, the harder it will be in the future to ignore it or continue to go around it, or actually get up it.  So going around and avoiding the cliff entirely isn’t a long-term option, nor necessarily the best option even now.  CBO explains the policy options, which I’m labeling as different strategies for driving the train called the U.S. economy toward the 2013 fiscal train stop.  The CBO concludes that there are three basic options (my labels and emphasis added):

What Might Policymakers Do Under These Circumstances?

[1: "Going Around the Cliff, For Now"]  They could address the short-term economic challenge by eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years—but that would have substantial economic costs over the longer run.

[2: "Running Head-On Into the Cliff"]  Alternatively, they could move rapidly to address the longer-run budgetary problem by allowing the full measure of fiscal restraint now embodied in current law to take effect next year—but that would have substantial economic costs in the short run. Or,

[3: "Grading the Cliff Into a Climbable Hill"]  if policymakers wanted to minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist, they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.

In other words, the U.S. economy does face an “uphill battle” in terms of the fiscal outlook; heading to higher ground (meaning lower deficits), eventually, is unavoidable.  But to quote from a particularly wise engine, “I think [we] can” do it.  The 2013 fiscal cliff is at least an opportunity to take a constructive attitude toward climbing that hill, and hopefully our policymakers, after the election, might have the wisdom and courage and work ethic needed to start turning that fiscal cliff into something our economy can more easily and successfully climb.

This is an old theme  here, but the issue and the confusion persists, as I have just come from attending the Peter G. Peterson Foundation’s fiscal summit today, complete with a protest/press conference  on the front steps of the summit venue, with the protesters arguing against the “austerity” measures they think the summit participants and attendees advocate.

Just coincidentally, here is a blog post I wrote on Concord’s blog today.  In it, I say deficits can sometimes be good, and deficits can sometimes be bad, depending on the condition of the economy (emphasis added):

In a recovering economy still below “full employment” level, the binding constraint is lack of demand for goods and services. Increasing the supply of productive resources won’t increase GDP if there is already excess supply, or idle capacity, in the economy. It will only increase unemployment. In such an economy, fiscal policy can increase GDP by stimulating consumption — either through the government’s direct purchases of goods and services, or through tax cuts or transfer payments that indirectly increase private spending. Deficit spending can be effective at increasing demand and GDP immediately; how effective it is depends on how well targeted the policies are toward households and businesses most likely to spend additional funds on goods and services, and on how much the industries that produce those goods and services respond by hiring additional workers.

Sudden fiscal consolidation or deficit reduction, on the other hand, can jeopardize an economic recovery if it substantially reduces the net incomes of households that spend most of their income. (Such “austerity” measures can also spur a political backlash, as we are seeing now in Greece and France.)

In contrast, in a fully-recovered, full-employment economy, the size of the economy is limited by the level of productive capacity, or the aggregate “supply side” of the economy. Increasing demand without increasing supply only creates inflationary pressures. Under these conditions, higher private and/or public saving will most effectively expand the economy.

Deficits harm economic growth by reducing national saving (public plus private saving), which reduces the capital stock, labor productivity and household incomes. So deficit financing of tax cuts or spending designed to encourage the supply of productive resources handicaps the likely payoff. If policies can be structured to preserve the positive incentive effects on the supply of labor and capital while avoiding deficit financing, then those policies are much more likely to increase GDP.

As the economy gets closer to full employment and there is less need to stimulate demand, fiscal policy should transition from deficit-financed policies that encourage consumption, to paid-for policies that increase national saving.

And just because deficit spending in general can be helpful in a recession and recovery and harmful in general in a recovered economy, doesn’t mean all deficit spending is equally good in a recession and recovery, or all deficit spending is equally bad in a full-employment economy.  There are benefits and costs in either situation that should be evaluated as thoughtfully as possible in order to maximize the net benefits of the policy.

So I don’t support “austere” fiscal policy, but I do keep hoping for “smarter” and (net) beneficial fiscal policy.  It is not at all hard to do in economic theory.  The difficulty lies mostly in political practice.  I’ll explain more on that soon when I write more about what happened at today’s fiscal summit.

Here is the last of my “Taxes for a Civilized Society” columns, published in Tax Notes last Monday, reprinted in full with the permission of Tax Analysts.

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This is my last column as a regular contributor to Tax Notes, so I thought I would close with a focus on my favorite tax topic, which somehow manages to stay evergreen because policymakers never quite settle the issue: the Bush tax cuts.

Policymakers are headed toward a big fiscal cliff after the election, with the expiration of the Bush tax cuts this time joined by automatic spending cuts known as the sequester. The looming sledgehammerlike spending cuts of about $1 trillion over 10 years have caused a panic. But the expiring tax cuts are worth several times that — more than $2.8 trillion over 10 years, or more than $4.5 trillion including alternative minimum tax relief, even without counting interest costs.¹ It’s a good reminder that the most important aspect of the Bush tax cuts (leaving aside the politics) is their cost.

Instead of complaining about the size of the Bush tax cuts and not doing anything constructive about it, policymakers ought to commit to using that size in a positive way. The fact that we have a valuable policy lever available to us is fortunate.

Keep Them, but Pay for Them

Everyone loves the Bush tax cuts because they’re tax cuts. They increase after-tax incomes for most of us, so we personally benefit. The problem has been that financing them has kept the true cost out of the awareness of policymakers and the general public. The benefits of the tax cuts have been private goods, but the costs have been public bads.

Congressional Budget Office projections have shown repeatedly that achieving the current-law baseline level of revenues — the level consistent with letting all the expiring tax cuts actually expire — is one way to get us to an economically sustainable level of deficits over the next decade or two. (Beyond that we will need to cut net spending associated with the retirement programs.) But as I’ve emphasized many times, achieving current-law baseline levels doesn’t have to mean literally sticking to current law and letting the tax cuts expire as scheduled. It could instead mean paying for any of the tax cuts we choose to extend.

The question policymakers and the public must ask ourselves is not whether we like or have enjoyed having the Bush tax cuts, but which part of them we love the most, and whether we love them enough to be willing to pay for them. Do we prefer the Bush tax cuts (any part of them) to the other types of tax cuts (such as expensive tax expenditures) or areas of spending that would need to be given up to offset the cost of the Bush tax cuts?

If the answer is yes, then by all means we should extend those portions of the Bush tax cuts. Being forced to pay for something is a great way to figure out how valuable it really is. Having Bush tax cuts that are compliant with “pay as you go” rules also would preserve the private benefits of the tax cuts we choose to extend, while getting rid of the associated public cost of higher deficits.

Let Go of Them to Pay for Better Policies

If we decide not to extend the tax cuts, it’s probably because there is a more attractive policy alternative.

The several-trillion-dollars cost of the Bush tax cuts is huge, yet the evidence of their economic benefits has been limited. If you go back and read several past issues of the “Economic Report of the President” from the George W. Bush administration, you will notice that its praise of the Bush tax cuts mainly emphasizes how large they were (and still are). But that is an endorsement of the large income effects of the tax cuts — effects that would occur under any cost-equivalent tax cut or spending increase. Holding the cost of the tax cuts constant, we have to ask: Are there alternative tax cuts or spending that would achieve better economic effects in terms of microeconomic incentives, macroeconomic impacts, and the distribution of income?

For example, we may need the Bush tax cuts to continue because our economy can’t handle that large of a withdrawal of fiscal stimulus at once. But there might be alternatives that provide more bang for the buck. We may want to keep the lower marginal tax rates under the Bush tax cuts to encourage the longer-term, supply-side growth of the economy, but are there alternative tax cuts or spending increases that could do better at increasing human capital formation, labor supply, and investments in new and socially valuable technologies? And could even deficit reduction be a surer route to economic growth than the Bush tax cuts have been? The answer to both is yes — which means we should want those alternative policies and deficit reduction more.

Use Their Expiration for the ‘Buffett Rule’

One way in which the Bush tax cuts have clearly been viewed as not economically helpful has been regarding the distribution of income. President Obama has always complained about the unfairness of them — how they have given the lion’s share of their benefits to the rich. Obama repeatedly addresses his complaint by proposing to let expire only the top two brackets of the cuts — the brackets that affect only households with annual incomes exceeding $250,000. But that doesn’t mean the rest of the Bush tax cuts (still worth more than $2 trillion over 10 years) would not benefit households now in the top brackets.

In fact, even if the top two brackets (now at 33 and 35 percent) reverted to their pre-2001 law levels (of 36 and 39.6 percent), households in them would still benefit the most in dollar terms from the extended lower rates in the lower brackets. The rich would still be receiving a disproportionate share of the Bush tax cuts — no longer disproportionate relative to their shares of income, but still disproportionate relative to their shares of the population.

Because the $2.8 trillion in tax cuts disproportionately benefits the rich, letting them all expire would raise the tax burdens of the rich. In an earlier column, I pointed out that although the millionaires’ share of the tax burden of letting all the Bush tax cuts expire is much smaller than it would be if only the upper-bracket Bush tax cuts were allowed to expire, the additional tax revenue collected from millionaires would be higher under full expiration.²

Whether all of the Bush tax cuts or just the upper-bracket ones are allowed to expire, the result would be greater progressivity. Such a policy decision could be taken as a proactive component of any “Buffett rule.” Ideally, the expiration of some or all of the Bush tax rates, which on its own would generate reduced incentives to work and save, could be coupled with base-broadening reforms that would help promote the Buffett rule by reducing tax expenditures that solely or disproportionately benefit the rich but would also reduce rather than increase the distortions of the income tax system on economic decisions.

Let the Budgeteers Take Control

Given that the most valuable thing about the Bush tax cuts is their cost rather than the merits or flaws of the structure of the policy in terms of its base and rates, the budget committees and budget process will be a big deal in terms of what will happen to the tax cuts. The difference between “business as usual” deficit financing and the outcome if pay-go rules are applied without exception is more than $4.5 trillion over 10 years.

The budget committees should flex their policy muscles and do the heavy lifting regarding the impending expiration of the Bush tax cuts. They could propose legislation requiring strict pay-go rules on the tax cuts and setting revenue levels in the budget resolution consistent with letting the full complement expire. They could also explain and illustrate how complying with pay-go doesn’t have to mean increasing tax burdens at a time when our economy cannot handle it. Any part of the tax cuts that we want to extend immediately can be paid for with gradual revenue increases or spending cuts over the rest of the 10-year budget window. And while the budget committees cannot dictate the specifics of tax policy (that is left up to the House Ways and Means and Senate Finance committees), they are the ones that set the ground rules and boundaries that the taxwriting committees must work within.

The budget committees also have the option of at least stating their preferences about the specifics of tax policy (such as the mix of rate increases versus base broadeners in the revenue-raising strategy) in the policy sections of the budget resolution or in the committee reports accompanying the legislative text of the resolution.

Politically, the hardest part about making the best of the Bush tax cuts has always been paying for them. That is why the role of the budget committees and the budget process is unusually critical on this particular, and large, tax policy decision.

Deal With the Turkey in the Lame Duck

All these ways of making the best of the Bush tax cuts are not precluded by the fact that this is a presidential as well as congressional election year. If we consider the many ways in which policymakers have failed over the years regarding decisions about what to do about the Bush tax cuts, it’s clear we can’t blame just the budget committees for not putting their foot down about the current-law baseline and pay-go. When Obama and Republicans want to keep extending and deficit-financing them, we can understand why Congress on its own was unable to get its bipartisan act together and behave better. Doing the right thing by the Bush tax cuts requires strong leadership unencumbered by unrealistic campaign promises.

There are several reasons to be optimistic about doing better once we get past the next election. The near-term economy is not as fragile as it was two years ago, the last time the Bush tax cuts were about to expire, making the idea of letting go, even gradually, more palatable. At the same time, the various debt crises in Europe serve as a warning about the unsustainability of the U.S. fiscal outlook and its implications for the economy in terms of longer-term growth and shorter-term stability.

Finally, after this November’s election, no matter who is elected president, we are likely to have a president who is less tied to a campaign promise that commits him to keeping the Bush tax cuts and who was voted into office by a public that is now far less enamored of the Bush tax cuts than it has ever been.

The cliff on the Bush tax cuts comes less than two months after the election. Is that too little time to do better than business as usual? While it may not be possible to replace the Bush tax cuts and the rest of the federal income tax with a full-out version of base-broadening, rate-reducing, revenue-raising fundamental tax reform like the plans recommended by bipartisan groups, it is not hard to set a goal in the lame-duck session of making only positive, even if small, steps regarding the Bush tax cuts. In the lame-duck session, Congress and the administration can commit to either letting parts of the Bush tax cuts go or turning them into more fiscally responsible versions that achieve better economic results.

At a minimum, policymakers should not have to revert to full extension of the cuts as a form of compromise as they have done in the past. Deficit-financed extensions should be limited in scope and temporary in timing, and permanent extensions should comply with strict pay-go rules over the 10-year budget window. Policymakers will be able to do this with the help and leadership of the budget committees working with a president who is able to get off the campaign trail and back to work, all of them cheered on by an American public that well understands by now the inevitability and necessity of hard choices. They can turn this turkey of the Bush tax cuts into something much better.

¹ Congressional Budget Office, “The Budget and Economic Outlook, Fiscal Years 2012 to 2022,” Jan. 2012, Doc 2012-1855 , 2012 TNT 21-26 .

² Diane Lim Rogers, “Who Wants to Tax a Millionaire?” Tax Notes, Feb. 6, 2012, p. 725, Doc 2012-1867 , 2012 TNT 24-16 .
END OF FOOTNOTES

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Less time required for Tax Notes means maybe, finally, more time to get back to this blog!  And I have a new project developing that I hope to be able to tell readers about soon.  Thank you for sticking with me through thick and thin here!

My final column with Tax Notes as a regular contributor came out today, available here if you are a subscriber.  If not, you will have to wait until next week when I will reprint the column in full here.  The title is “Making the Best of the Bush Tax Cuts,” and the main point I make is that of all the possible economic effects of the Bush tax cuts, and all the arguments made about the cuts (for or against them), by far the most significant, most noted, most praised or most maligned characteristic has been their size (or revenue loss).  Even supply-side proponents of the Bush tax cuts hardly ever talk about the supply-side effects of the tax cuts in truly supply-side terms; i.e., they don’t try to argue that the incentive effects of lower marginal tax rates on labor supply or private saving have been huge.  They just talk about how the tax cuts have been huge, and so wouldn’t it be bad if they went away?  Liberals have argued that the tax cuts have been costly and have disproportionately benefited the rich, meaning the government has given away a huge amount of money to the rich, so wouldn’t it be good if they went away?  So the bottom line is that for all the talk of all the promising, bipartisan ideas for tax reform that would reduce the deficit, there is still huge disagreement about what to do with the huge thing known as the Bush tax cuts.

But it’s a good thing that we still are debating this topic, because it means we still have some choices to make over a huge pot of money.  In my column, I try to pitch this optimistic view:

Instead of complaining about the size of the Bush tax cuts and not doing anything constructive about it, policymakers ought to commit to using that size in a positive way. The fact that we have a valuable policy lever available to us is fortunate.

It is obvious by now, after all these years of arguing about the Bush tax cuts but continuing to keep them just as they are, that the disagreement is not over the shape of tax reform we’d all like to see (broader base, fewer tax expenditures that upside-down subsidize the rich, low marginal tax rates), but rather over the size of the revenue stream we should be collecting under this beautifully bipartisan (but still hypothetical) tax reform.  That’s why it surprised me when at last week’s tax reform event hosted by the Brookings Institution’s Hamilton Project, none of the experts emphasized a point that I do in my final Tax Notes column:  that this is more a disagreement over budget policy than tax policy, which means that the budget process and budget rules will be unusually important to the success of any deficit-reducing tax reform effort in the next few months and years–which means that, oddly enough, the budget committees may be more important players in achieving tax reform than even the tax-writing committees.  While the budget committees have not had much say on the issue of the Bush tax cuts up until now, in my column I offer up several reasons to be more optimistic about the future, including the possibility of better dealing with the “turkey” (aka the Bush tax cuts) in the “lame duck” session:

All these ways of making the best of the Bush tax cuts are not precluded by the fact that this is a presidential as well as congressional election year. If we consider the many ways in which policymakers have failed over the years regarding decisions about what to do about the Bush tax cuts, it’s clear we can’t blame just the budget committees for not putting their foot down about the current-law baseline and pay-go. When Obama and Republicans want to keep extending and deficit-financing them, we can understand why Congress on its own was unable to get its bipartisan act together and behave better. Doing the right thing by the Bush tax cuts requires strong leadership unencumbered by unrealistic campaign promises.

There are several reasons to be optimistic about doing better once we get past the next election. The near-term economy is not as fragile as it was two years ago, the last time the Bush tax cuts were about to expire, making the idea of letting go, even gradually, more palatable. At the same time, the various debt crises in Europe serve as a warning about the unsustainability of the U.S. fiscal outlook and its implications for the economy in terms of longer-term growth and shorter-term stability.

Finally, after this November’s election, no matter who is elected president, we are likely to have a president who is less tied to a campaign promise that commits him to keeping the Bush tax cuts and who was voted into office by a public that is now far less enamored of the Bush tax cuts than it has ever been.

I’ll repost the column in full here next Monday.  (PS: Like any commentary on the Bush tax cuts, it seems, the cartoon above is old yet still timely; I have used it on my blog before.)

Yesterday (on “Tax Day”) NPR’s Scott Horsley was wondering about the prospects for doing something better about the Bush tax cuts this year.  He got a similar reaction from me, NYC Mayor Michael Bloomberg, and the Tax Policy Center’s Bob Williams–although I got to pull out an expression I believe my mom first taught me, “benign neglect.” (My mom is going to have to remind me in what context she would throw out that term, frequently.)  From the transcript (please go to NPR site to hear the full audio):

The tax cuts championed by President George W. Bush a decade ago, and extended in 2010, are due to expire at year’s end. That would mean higher taxes at every level of income, as well as higher taxes on dividends, inheritance and capital gains.

“The biggest hits would be on the very wealthy,” says Williams. “Those are the people who’ve benefited most from the Bush-era tax cuts. But people at the very bottom would be hit as well.”

All of this will happen automatically unless Congress and the president act in concert to prevent it.

“It’s the do-nothing option,” says Williams. “If Congress does nothing, taxes go up automatically.”

Not everyone is alarmed by that.

New York Mayor Michael Bloomberg told CBS last month that taxes have to go up for everyone in order to put a dent in the federal budget.

“Most of this country is middle class. And that’s where most of the tax revenue is. So if you want to raise $4 trillion over the next 10 years, which gets you halfway — only halfway — to a balanced budget, everybody’s taxes have to go up,” said Bloomberg.

Action, Or ‘Benign Neglect’?

Economist Diane Lim Rogers of the deficit-watchdog Concord Coalition agrees that stemming the tide of red ink will require more tax revenue. But she sees some problems with letting the Bush-era tax cuts expire all at once.

“It wouldn’t be the worst thing that could happen,” says Rogers. “I think economists would prefer that instead of things happening out of benign neglect, that better things could happen out of good policymaking.”…

I don’t know why I said “economists” would prefer; heck, everyone should prefer that, as long as we have some faith in the role of government to promote the public good. I had elaborated to Scott that the economists’ problem with just letting the tax cuts all expire is that we have other options to raise revenue that economists would consider more efficient and just as or more fair.

I go on to talk about my second favorite tax topic after the Bush tax cuts: tax expenditures and the need to reduce them as a way of cutting government spending in a progressive manner.  I am still hopeful that after we go through all the other possible ways to reduce the deficit and realize we won’t accept much of them or that they don’t work, we’ll come back to the goal of pursuing sensible tax reform.

Video streaming by Ustream

As we arrive at the federal tax filing deadline (this year on Tuesday, 4/17), it just so happens that Congress and the Administration have been thinking of different ways to raise tax burdens on the rich.  Last week I participated in a “Tax Day” event at the Tax Policy Center called “Should the Rich Pay Higher Taxes?” as one of the “four Ds” panel which also included TPC’s director Donald Marron, former CBO director and former McCain adviser Doug Holtz-Eakin (now president of American Action Forum), and economist rich guy (and a member of the “Responsible Wealth” coalition) David Levine.  The TPC has our handouts and a video of the event posted here.  (The video is also embedded above.)

TPC’s Howard Gleckman moderated the event (and blogged about it afterward, here) and at one point asked each of us “who is rich?”  I at first didn’t know how to answer that; “rich” is a relative concept that depends on one’s personal “baseline,” of course!  But then I circled back to the focus of the event–what the tax burdens of “the rich” should be–and I realized that in that context, all federal income taxpayers should be considered “rich,” in that we are all, all combined at least, paying too little in taxes.  Revenues as a share of GDP are far lower right now than the 18 percent historical average over the past several decades, which is too little anyway to produce economically sustainable budget deficits now and going forward (let alone enough to cover spending fully).  And although a lot of that currently-below-average level is because of the short-term but stubbornly persistent weakness in the economy (a cyclical phenomenon), projections show that even when the economy gets back to “full employment” and even when revenues/GDP recover back to and above the historical average (even under the policy-extended baseline, by the way), revenues are still not going to be enough to keep up with the growth in government spending–even if health reform (already in place and to come) successfully reduces the growth in Medicare spending.

So if “the rich” are defined as those who can afford and ought to be expected to pay higher income taxes, then “the rich” really has to be much more broadly defined than “people like David Levine” (who are multi-millionaires).  And if you watch the video of the TPC event, we all pretty much agreed on the premises that: (i) we need more federal revenue; (ii) “the rich” can manage higher tax burdens the best (and should be asked first); and (iii) David definitely qualifies as “rich.”  We had more differences in opinion over: (i) how much more revenue we need (and implicitly, what the right size of government is); (ii) how that revenue should be raised in terms of base-broadening vs. rate-raising reforms; (iii) what the right basis of taxation is–income or consumption; (iv) if David’s wealth comes more from his high productivity and hard work, or more from good luck; and (v) if raising tax rates on people like David will cause them to not work so hard, or if it just means they will not be as “lucky” in terms of their tax burdens.

David is practically begging to make him, and other millionaires like him, pay higher taxes, and feels the best (maybe easiest) way to do so is in the latest legislative version of the “Buffett Rule”–which basically imposes another “alternative minimum tax” to brute-force effective tax rates on the incomes of the rich to be at least 30 percent, without changing (improving) the definition of taxable income.  I and Donald agreed that David can afford to face a much larger tax bill, but that it would be better (more economically efficient and better for supply-side incentives) if his burden were raised by paring back the tax subsidies David receives via, for example, itemized deductions and the preferential tax rates on capital gains and dividend income.  Doug also agreed that the best way to raise tax burdens on the rich is to reduce tax expenditures rather than raise marginal tax rates, but he did not count the preferential rates on capital income as a tax expenditure (because he advocates consumption as the right basis of taxation), and also probably would not agree with me and Donald on how much revenues/GDP need to rise.  And all of us, being economists, agree that in theory and all else constant, higher marginal tax rates can discourage the incentives to increase the supply of productive resources (via working and saving) to the economy.  But if there’s one thing that economist and rich guy David made clear in telling of his own personal experience with wealth and taxes, it’s that even for really rich people, the economist-labeled “income effects” of taxes–the effects of having more or less after-tax income–are typically far bigger than the economist-labeled “substitution effects” of taxes–the effects of marginal tax rates on relative prices which cause people to substitute away from taxed or higher-taxed activities and into untaxed or lower-taxed ones.  I feel that conservatives (like Doug) who want lower marginal tax rates tend to over-sell the empirical significance of those substitution effects, yes, but liberals (even rich ones like David) tend to forget that as long as some substitution effects exist, it’s better to raise tax burdens by broadening the tax base (in a progressive manner) than by raising the top marginal tax rate.

So, the TPC event made clear that “yes, the rich should pay higher taxes.”  But it also highlighted where the challenges to achieving fundamental tax reform will be, in coming to agreement about who exactly is “rich,” and how exactly they will be made to pay more in taxes. We have far more work to do regarding federal tax policy than what is currently being debated–in a very narrow sense–about the “Buffett Rule.”

The former president may speak more eloquently than we’ve heard him speak before about his tax policy (perhaps taking some talking points from Paul Ryan?), but the bad news is that simply re-labeling the tax cuts as, for example, the (now) “Obama tax cuts,” won’t make those claims of wonderful supply-side growth effects suddenly come true. (Here is a CNN story on yesterday’s speech.) But the new presidential ownership of the bulk of the tax cuts–and the continued campaign promises by all candidates to keep the bulk of them (warts and all)–still assures us that they’ll largely persist in our future.

Today House Budget Committee chairman, Paul Ryan (R-WI) unveiled the House Republican budget proposal with a lot of fanfare and his latest snazzy video.  The fundamental structure of the proposal itself is not really “news” in that Ryan has remained consistent to his word that the fiscal situation is a spending-side-only problem and that the level of revenues as a share of our economy should be maintained around its 40-year historical average.

Relating that to the story on the Senate Budget Committee chairman, Kent Conrad (D-ND) which appeared over the weekend in the Washington Post (written excellently by Lori Montgomery), I find it striking that both of the budget chairmen (from the two different houses and two different parties) now talk about tax expenditures as government spending that just happens to be done by poking holes into the income tax system.  In his own budget, Ryan refers to this “spending through the tax code” (pg. 67) and also points out how the rich benefit the most from these “tax subsidies.”  In other words, like Kent Conrad, Paul Ryan recognizes that if we reduced these tax expenditures, we would not be raising taxes as much as reducing spending.

On the other hand, Ryan stresses that his proposal to eliminate these tax subsidies would be “not for the purpose of increasing total tax revenues, but instead to lower rates.”

So, revenues relative to GDP remains the huge sticking point in what would otherwise seemingly be complete bipartisan agreement on the shape of badly-needed tax reform.  How best to break that impasse is the key to making huge progress on deficit reduction.  I think it will have to wait until after the election, however, because for now the Democrats would rather attack the Republicans for their deficit-reduction approach that implies huge, draconian cuts in direct spending and benefits than convince the Republicans to move away from that approach and more toward revenue-raising-but-by-base-broadening tax reform.  And Republicans would rather attack the Democrats for their strategy of  “soaking the rich” (and the “job creators”) than convince the Democrats that broadening the tax base by reducing tax expenditures is actually a progressive (as well as efficient) way to raise tax burdens on the rich.

My latest Tax Notes column which came out today (subscription-only access here) is basically a recap of my testimony on March 1st before the Senate Budget Committee.  It’s a written version of the script I used for my oral remarks, plus a chance to report (or vent) about the line of questioning that came from one of the Republican senators that day.

About the basic premise of the hearing, which was called “”Tax Reform to Encourage Growth, Reduce the Deficit, and Promote Fairness,” I explain that:

I recently heard the three tax reform goals listed in the hearing’s title referred to as a “fiscal trilemma,” suggesting it might not be possible to achieve them all.² Equating the three with a dilemma suggests that working toward them will be a negative experience. Indeed, many policymakers are caught speaking of at least one of the goals with partisan disdain: “encouraging growth” (a popular Republican goal) might be labeled by some Democrats as “pandering to the rich”; “reducing the deficit” by including at least some new revenue (a popular centrist goal) might be labeled by some on both sides as “killing jobs”; and “promoting fairness” (a popular Democratic goal) might be called “class warfare” by some Republicans.

Nonpartisan economists would respond that all three goals will benefit the economy. And the good news is that it really is possible to find tax policy changes that would help achieve all three goals — and possibly help achieve simplicity. That good news is doubled by the recognition that different policymakers actually like all the goals more than they’ll admit in public, but they assign different implicit weights to the different goals — suggesting that the only way to ensure bipartisan agreement is to make sure a proposal helps achieve all three goals.

I then explain the problem with the tax policy “fairy tale” that sounds so happy and easy:

[M]any so-called tax policy experts spin a simple fairy tale when they talk about how to reform the tax system. They say that we just need to cut tax rates, which will expand the economy, which in turn will reduce the deficit. But unfortunately, in the real world, we face real budget constraints and a real scarcity of resources. Real economists know that optimizing means not just maximizing benefits but weighing benefits against costs so that benefits net of costs are maximized. In the context of the real world and our experiences with the economic effects of different tax policies, cutting tax rates to achieve all of our goals is pure fantasy.

I made three main points in my testimony regarding the goals of encouraging growth, reducing the deficit, and promoting fairness:

1. It is impossible to expand the supply side of the economy through continued, seemingly easy, deficit-financed tax cuts.2. It is impossible to reduce the deficit without allowing, and even seeking, higher revenues as a share of our economy.

3. It is impossible to promote fairness in the tax system without raising tax burdens on the rich.

And the only part of the Q and A where I have to admit I felt a bit “bullied” was this:

One of the more hostile exchanges at the hearing was when Sen. Ron Johnson, R-Wis., questioned what we thought the maximum marginal tax rate should be. Each time [Len] Burman [of Syracuse, the other witness invited by Chairman Conrad] and I tried to respond that it depends on the breadth of and distortions within the existing tax base, Johnson interrupted and insisted on our providing a specific number without any qualifications. It was obviously a setup, as [Dan] Mitchell [the Republican witness from the Cato Institute] described in a blog post. Although I reluctantly gave a specific answer of 70 to 80 percent, I wasn’t advocating a marginal tax rate that high but only responding that a total marginal tax rate — combining taxes at all levels of government — any higher than that would be a bad idea. I tried to point out that the maximum marginal tax rate could mean the rate on the richest person in the country’s last dollar earned. I believe 70 to 80 percent is around Laffer curve levels — the highest rate possible before revenue is lost. [In the Tax Notes column I cited this NBER paper by Christina and David Romer.]

That maximum marginal tax rate is totally different, however, from the survey results Mitchell cites that show people not wanting anyone to be taxed at more than 30 percent. Mitchell understandably likes the interpretation that ordinary Americans are referring to the maximum top marginal tax rate bracket. But I really doubt that most Americans understand the difference between marginal and average tax rates, or if they do, that they are inclined to automatically think top marginal rate (on the last dollar earned) when asked about the maximum tax rate that top earners should pay. When thinking about what’s fair, I think most people have in mind the common-sense statistic of taxes paid relative to income, or the average tax rate.

In fact, if the very richest people in America faced a marginal tax rate on their millionth-plus dollar earned of 70 to 80 percent, their average tax rate would still very likely be close to 30 percent. We might contemplate such high marginal rates at the top if we had failed to achieve the best solution of broadening the tax base and we were trying to make the tax system more progressive (while raising revenue for deficit reduction) by only raising — or creating new — top marginal tax rate brackets.

[But] Let’s be clear that I spent the whole hearing advocating for base broadening that would keep rates low. But I was asked what the maximum top marginal tax rate could be that the economy could handle, regardless of how successful or not we might be with base broadening efforts…

I encourage EconomistMom readers to view the hearing video and judge for yourself whether Senator Johnson was playing nicely or not.  Either way, I don’t think his or Dan Mitchell’s view that marginal tax rates on the rich are already high enough to be worrisome has much basis in reality.  (Nor did the story that came out the very day of the hearing (March 1) about Dan Mitchell’s organization, the Cato Institute, and how much it is influenced by the Koch brothers, help Mitchell’s credibility as an objective and fact-based economist.)

Even so, I still would prefer we raise revenue by not raising marginal tax rates further and instead broadening the tax base (reducing tax expenditures) in (very easily) progressive ways.  The “trilemma” of tax reform is entirely possible to achieve and is actually the best way to succeed, politically and economically, in doing good tax reform.