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TagsBY MICHAEL BUSLER
COMMENTARY
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?
The President is correct when he says that extending the tax cuts for the top 2% of income earners will do nothing (in the short term) to stimulate the economy. He correctly says that these people will likely not spend any of the tax cuts. So why does it benefit all of us?
While almost all of us spend more than 95% of our disposable income, the wealthy 2% spend a much much smaller percent, sometimes as low as 10%. Which means, that instead of spending their disposable income, they save or invest a very large portion. In fact the majority of investment capital comes from this source. So, if the tax cuts expire for the wealthy, the amount of investment capital available for business to expand is reduced, especially in an environment where the federal government is siphoning trillions from capital markets because of the large deficits. That leads to a capital shortage as business is "crowded out" of capital markets.
The result hurts all of us. With President Obama stimulating demand by extending the tax cuts for middle America, business should see increased activity. When more customers seek to buy more products, business has a choice to make. Their first choice is to expand output to meet the increased demand. This is what everyone wants. But in order to expand output they need to hire more workers and they need to raise more capital. Because of the high unemployment, there is plenty of labor available. However, if they are crowded out and there is no capital available, they cannot expand. This gives them no choice but to raise prices to meet the increase in demand. We end up with stagflation, which is a stagnant no-growth economy accompanied by high inflation.
We had a similar problem in the late 1970's. There was a severe case of stagflation. In fact, by 1980 we had double digit unemployment and double digit inflation. In addition, there were large government deficits brought about by increases in government spending and high personal tax rates, especially on the highest income earners. So how did we fix it?
We cut taxes for everyone especially — including the wealthy. This lead to increases in demand as well as increases in capital formation. The result was, except for barely noticeable hiccups in 1991 and 2001, a 27 year expansion. We need to do that again. Extending the tax cuts, especially including for the wealthy, will benefit all of us.
Michael Busler is an Associate Professor of Finance and a Fellow at The William J. Hughes Center for Public Policy at Richard Stockton College.
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Furthermore, the notion that America can do stimulus spending while continuing to cut taxes has to stop. Cutting taxes, many economists say, is a poor form of stimulus, in part because it takes too long for its affect to work. Currently, some 47% of wage earners pay no federal income tax, and the bulk of the income tax burden is born by the top 53%.
Unless I am seriously in error, Pres. Obama says that tax cuts will remain for those in the middle and lower classes, but will revert to old levels for the wealthy. Why not? The wealthy can pay these taxes with little real pain, albeit unwillingly; who, after all, likes to pay taxes?. It is as wiser people than I have pointed out, the price for a civil society.
Americans have enjoyed one of the lowest tax rates of any of the producer nations for decades, and now we're paying the price for it. We should have been paying it all along.