Decades from now, when historians look back at the “fiscal cliff” crisis of 2012, they are likely to find it the greatest ado about nothing since the turmoil in Andrew Jackson’s administration because Mrs. John C. Calhoun snubbed the wife of his war secretary. Remember that?
The underlying issues are important, to be sure. But the substantive differences between the two sides are not all that great, even while the level of rhetoric and political posturing is extreme.
Once again, the good sense of 80 percent of the citizenry clustered around the political center is being overwhelmed by elected officials cowed by the 10 percent on their respective wings.
Start with the basic issue of marginal personal income tax rates. Moving the top rate from 35 percent to 39.6 percent is not likely to have discernible effects on growth or employment. The rate has been that high or higher for 64 of the past 80 years. It was 90 percent from 1951 through 1963 and remained at 70 percent or more for the rest of the 1960s. This was the period of greatest growth of median incomes and productivity in this eight-decade span.
They remained above 50 percent for most of the Reagan era before dropping to 28 percent in 1988. Predictably, annual deficits grew sharply until presidents George H.W. Bush and Bill Clinton had the guts to ask for legislation to recoup about half of the cuts. Despite wild rhetoric about how this was going to sink the economy, the rest of the 1990s saw good growth.
While we still had a “structural deficit” (i.e. one over the long run if the economy were not booming), we did manage four years of slight budget surpluses, the first since LBJ’s belated tax boost had last balanced the budget in fiscal year 1969.
We threw that away with the 2001 and 2003 tax cuts, which needed a statutory end date of 2010 to hide the fact that they would make the deficit explode over the longer run. These were supposed to spur economic activity. Instead, we had the slowest economic growth of any decade since the Great Depression, even if taken only through the good times that ended in 2007.
Now you might say that there were many other factors that drove 1990s growth, including a one-time technology boom and the Alan Greenspan-led Federal Reserve beginning to goose the monetary throttle as the decade ended. Oil prices also were low relative to longer-run trends.
Similarly, after 2001, the economy had severe exogenous shocks from the 9/11 attacks and the subsequent slump in air travel. We had high oil prices from ongoing turmoil in the Persian Gulf. And we have had five years of financial-sector crises. Admittedly, higher tax rates did not cause the good growth of the 1990s and lower ones were not responsible for the bust in this century. Other factors were more important.
But that is precisely the point. No economist would argue that tax rates and the structure of taxes have no effect on economic growth. But it similarly is hard to find a reputable one who argues that any of the sundry income tax rate changes since 1981 made much difference on overall growth. Other factors were more important, for good and for ill, for the past three decades and will be for the next three.
For an excellent exposition of this and other tax issues, see “Taxes in America: What Everyone Needs to Know,” by Leonard Burman and Joel Slemrod. Slemrod, regarded by many as the nation’s premier tax economist served as a staff member on Reagan’s Council of Economic Advisors and is now at the University of Michigan.
Burman worked on taxes at the Treasury in the 1980s, was the tax expert at the Congressional Budget Office in the 1990s before serving as the deputy assistant secretary of the treasury for tax analysis for two years. Bruce Bartlett’s new “The Benefit and the Burden: Tax Reform, why we need it and what it will take,” also is excellent.)
If the president now demanded the top rate be pushed back up to 91 percent, or even the 50 percent that prevailed for most of the Reagan years, arguing about effects on growth would have more relevance. But he has not. And the business and household confidence needed for long-term economic growth depends much more on solving our budget quandary than on the exact level of the top rate.
Equally silly is the president’s insistence that any increase be limited to couples earning more than $250,000 per year. Worse, during the campaign he was wont to assert that the “middle class” really needed tax cuts. This was irresponsible demagogy.
Yes, since tax rates were last changed, nearly all the growth in real income has gone to the high-income group. But the average fraction of income paid as federal individual income taxes at all household income levels is lower now than at nearly any time since 1970.
For a median-income household of four, the fraction is half as large as it was in 1981. Yes, many people feel stretched right now. Yes, many people have seen stagnant incomes. But the fact remains that the burden of the federal individual income tax is lower than in the past.
All this would be less inane if the overall federal tax burden were high. But the fact is, that as a percentage of gross domestic product, total federal tax revenues are at their lowest levels in 60 years. And as long as it stays this low we are never going to put our fiscal house in order.
Equally unfortunate is much of the rhetoric about relatively modest changes in Social Security and Medicare.
Yes, moving from the consumer price index currently used to a chained index means that Social Security recipients gradually will see smaller payments over time compared with the current system. Yes, further raising the “normal retirement age” for Social Security or the eligibility age for Medicare will hit poorer people harder than rich people, since the poor are less likely to have good jobs into their late 60s.
Yes, the Medicare age increase would not save much money and savings to the program would be more than outweighed by cost increases elsewhere. And yes, there are better alternatives to achieve the same goals.
However, the fact remains that as now structured, these programs are not sustainable. If the measures advanced so far are unacceptable, then someone has to put these better alternatives on the table. The political reasons why both sides are reluctant to do so are obvious, but the common good requires someone to break the deadlock.
Furthermore, remember that any effort to shield those older than 60 from all pain means imposing even more eventual pain on those younger than 40. The baby boomers already are giving their own children and grandchildren one of the rawest deals in U.S. history, and I don’t understand why so many of us are willing to support measures that will make it even rawer.
For a longer exposition of this and other tax issues, see a presentation that University of Michigan economist Joel Slemrod made at a Heller-Hurwicz lecture at the University of Minnesota last October at http://hhei.umn.edu/TaxReform2012.php.