The end of midterm elections does not signal a break from intense politicking. Beginning in January, the new Republican House majority and the diminished Democratic Senate majority will be faced with a pressing task: determining the future of the Bush tax cuts.
The cuts, which are scheduled to expire at the end of this year, represent an issue that is surefire cannon fodder for a divisive debate. If, however, the new government can set aside its partisan platitudes for a short time, it could reach a compromise that would benefit most of the population while still minimizing damage to the deficit.
As they begin to examine if the Bush tax cuts should be extended, and for whom, lawmakers should remember two facts. First, making all of the Bush tax cuts permanent would cost the government roughly $4 trillion over the next decade. The cuts would lead to increased deficit spending, leaving our generation with the bill. Second, and in contrast, allowing the taxes to rise of those who spend the majority of their income (i.e., citizens in the lower and middle socioeconomic classes) during a recession is bad economics. So lawmakers face a dilemma: Extending the tax cuts for everyone while maintaining such extraordinary spending levels would break the bank, but eliminating them completely would hurt middle and lower class consumers.
Democrats want to strike a balance between these two considerations by extending the tax cuts, but only for families that earn less than $250,000 per year. The idea is that this policy would ensure that Americans who spend most of their income will not have to seriously cut their consumption, while also keeping the deficit in check. Republicans prefer to extend the cuts completely and to decrease federal spending to counter the cuts.
Congress should use these two proposals as starting points to negotiate a policy that maximizes the benefits of each. The most logical compromise is to retain the tax cuts for those who earn less than $500,000 and return the tax rates to their 2000 level for everyone above this benchmark. This piecewise solution will soften the Democrats’ deficit worries, as it will prevent the deficit from rising by hundreds of billions of dollars over the next 10 years, as it would if all the cuts were extended. And because 99 percent of American wage earners will continue to qualify for the cuts, it should assuage Republican anxiety.
Some conservatives have voiced concern that raising taxes on Americans earning more than $250,000 a year would unduly increase the tax burden on small businesses. Consider, however, that a great deal of income not traditionally thought of as “small business,” such as money earned by partners in law firms, income for hedge fund managers and royalties from publications, is treated as “small business income,” so the actual effect of a tax increase on small businesses is significantly overstated. Furthermore, raising the cap to $500,000 would shield many Mom-and-Pop small businesses from the tax increase.
Some politicians have also suggested a one-year extension of the current tax rates to give Congress extra time to address the issue. Putting off the debate, however, will leave households uncertain as to whether they will soon face increased taxes. As a result, they may begin to spend less, which would hurt the economy and defeat the purpose of the tax cuts.
Ultimately, it comes down to a numbers game. If both sides can come to the table with an open, rather than a hostile, attitude, they will find that raising the tax-break cap to $500,000 is an attractive, workable compromise – one that could shore up the country’s economy for the future, when our generation takes the reins.
