Congress has begun to debate extending the tax cuts that were enacted by President Bush in 2001. These tax cuts were supposed to last only ten years so they are set to expire at the end of this year. By not extending them we will, in effect, be raising taxes for every taxpayer, no matter what their level of income may be. In most cases, the increase will result in income earners paying 10% more tax dollars. Virtually everyone supports the extension. But do we support the extension for every income earner?
Raising taxes during a fragile recovery would have disastrous effects on consumer spending. Here's why: People do three things with their income. First they pay personal taxes. What's left over they are free to dispose as they please. (Economists call this disposable income.) Then they take, on average, more than 95% of this disposable income and spend it. The remaining less than 5% they save and invest. So if the tax cuts expire, taxes paid will go up, disposable income falls and consumer spending falls dramatically.
Since most of us (maybe as high as 98%) fit this pattern, President Obama says this is where the tax cut extensions would do the most good. This should increase demand and get the economy moving. And, he says, these are the people who need the tax relief. He further argues that the other 2% should not get the extension. They don't need it and, since the deficit is so large, we can't afford it. The reality, however, is that we can't afford not to extend it to the top 2%, since that tax cut benefits all of us. How?