by Maggie Mahar
healthbeatblog.org
December 15, 2010

When President Obama struck a deal with conservatives on tax cuts, his opponents set the stage for 2012. With this legislation, the conservative agenda of the Bush administration once again becomes national policy. The goal: to redistribute wealth upward--even if that means letting the deficit balloon.

Not long ago, conservatives on the Deficit Commission were warning that the deficit represents a “cancer” that will "destroy the country from within."

Now, politicians on the right are arguing for tax cuts that will add $858 billion to the deficit over ten years—plus $383 in interest over the same span—bringing the total impact on the national debt to $1.24 trillion through 2020. And somehow, that is suddenly a brilliant idea?

Trust me, there is a method to Mitch McConnell’s madness: The larger the deficit, the more compelling the conservative case for  shrinking entitlements such as  Medicare, Medicaid, Social Security and Health Care reform in 2012.

Slashing Income Taxes--Who Benefits?

By extending Bush-era income tax breaks for the rich, the compromise endorses “trickle-down” economics, a theory which says that if you cut taxes for the very wealthy, they will spend more, creating jobs and lifting wages for the middle-class. In fact, the past thirty years have taught us that “supply-side” economics is a myth. While the top 2% watched their marginal tax rate plunge, middle-class incomes remained flat to down. And the Bush-era tax cuts for the rich did little to stimulate the economy. (See this Health Beat post  for a chart which illustrates how middle-class incomes have stagnated, along with a table showing how marginal tax rates for wealthy Americans have fallen.)

Ignoring the lessons of the past, the McConnell-Obama compromise extends income tax cuts for those in the top 2% (individuals earning over $200,000 and couples bringing home more than $250,000) for another two years. Over that span, the windfall for high earners will boost the deficit  by roughly $80 billion. On average, the affluent households that benefit from these cuts will save $25,000 annually—or $50,000 over two years—assuming that the tax cuts are allowed to expire in 2012.

Granted, the middle class also will continue to enjoy the Bush-era cuts, at a cost of roughly $310 billion. But when that $310 billion is divided among 98% of the population, the benefit for any individual household will be modest.

Indeed, when you add up all of the tax breaks in the “compromise” legislation, the poorest 20 percent of Americans save just $396 in 2011, and the middle 20 percent wind up with $1,521. Meanwhile, the richest 1 percent will save $76,949, according to Citizens for Tax Justice.

Finally, what most pundits don’t mention when they talk about the income tax cuts is that, under the “compromise,” lower-middle-class Americans will wind up paying higher taxes. Families making less than $40,000 (and individuals earning less than $20,000) will lose refunds they received from the President’s “Make Work Pay” refundable tax credit that wasn’t part of the deal. (Thanks to Robert Borosage at “ourfuture.org” for highlighting this

Paring Social Security Taxes: A Hidden Agenda

Declaring a one-year “tax holiday,” the compromise legislation also offers to reduce the amount withdrawn from worker’s paychecks to fund Social Security. In 2011, the Social Security tax would fall from 6.2% to 4.2% of income up to $106,800.

The 2% cut in taxes masquerades as a tool to stimulate spending and create jobs. But as Marc Pascal points out on “The Moderate Voice”: “Cutting the payroll tax for social security is not a viable economic stimulus measure and it will not create any new jobs. It merely underfunds the program so Republicans can gut it later because it isn’t paying for itself.”

Many pundits have suggested that middle-class households will use a larger paycheck to purchase the things they have wanted to buy for the past year. This, in turn, will create the demand that companies are waiting for before they begin hiring.

But the truth is that for the average middle class family (with joint income of $60,000) the tax holiday means that they save roughly $100 a month—or $1200 a year. Some may use this modest windfall to pay down credit card debt. This would be prudent, but it won’t create jobs. And many others are likely to find that an extra $25 a week disappears very quickly as they pay higher prices for the necessities of life: health care, utilities, gasoline and food. (The U.S. Dept of Agriculture forecasts that food prices will rise by 2% to 3% next year.)  Because global demand for fuel continues to outpace supply, Goldman Sachs predicts that the cost of oil will rise more than 10% in 2011, and another 10% in 2012.

Of course those who earn more would save more. But since only the first $106,800, of an individual’s earnings are subject to the Social Secruity tax, even wealthy taxpayers will save only $2,100. Meanwhile, this provision adds another $120 billion to the deficit.

As for the motive behind the cut, Holly Sklar, executive director of Business for Shared Prosperity, agrees with Pascal: the hidden agenda is to fulfill one of George Bush’s fondest dreams—cut Social Security benefits—or, better yet, privatize the program, and let the private sector do the dirty work. She quotes Nancy Altman, co-director of Social Security Works; “President Obama and the Republicans will say that the payroll tax holiday is all about stimulating the economy. But don’t be fooled … There are many better ways to stimulate the economy with that $120 billion the tax holiday will cost, including simply extending the Making Work Pay Tax  Credit … And the other, better forms of stimulus pose no threat to Social Security.”

If legislators  wanted to give the middle-class a tax break, without reducing funding for Social Security—or adding $120 billion to the deficit—they could pay for the 2% cut by “scrapping the $106,800 cap on earnings subject to Social Security taxes,” Altman notes.  This would also “eliminate the projected Social Security shortfall.” Alternatively, one could simply lift the cap—say to $140,000—shifting the cost to those who earn more than $106,800, without in any way undermining a program that so many seniors depend on. But of course taxing the wealthy and saving Social Security is not part of the conservative blueprint for America.

Moreover, as we head into the 2012 election, Altman suggests that politicians are likely to extend the tax holiday. I agree. Thus she calls the so-called tax holiday a “grave threat” to Social Security: “Cutting the tax while leaving the cap is a gift to those who want to cut, privatize and destroy Social Security under the pretense of saving it.”

Dean Baker, co-director of the Center for Economic and Policy Research shares Altman's concern that the payroll tax cut will not sunset at the end of 2011, but will continue “indefinitely.” In that case, Baker observes, “Social Security's finances will appear much more shaky. As it stands, Social Security is fully funded through the year 2037, but that doesn't keep the Washington Post and National Public Radio from running endless scare stories about the program's funding crisis.

“If the payroll tax is permanently reduced by 2.0 percentage points,” Baker concludes, it would double the program's projected 75-year shortfall. This would give far more ammunition to the Social Security fear mongers.” This would also mean adding $120 billion to the deficit not just in 2011, but year after year.

Will Conservatives Let the Bush-era Income Tax Cuts Expire?

I also believe that income tax cuts for the top 2% will be renewed beyond 2012. Consider what that would mean for the deficit. According to the conventional wisdom, over ten years, the tax deal will add $858 billion to the deficit (plus $383 billion in interest)—but the CW “assumes that each component of the tax extension deal expires on schedule,” notes Ernie Tedeschi, an economic analyst for the Pew Economic Policy Group. Tedeschi is skeptical.

Writing on his blog, “Lobster Stuffed with Tacos,” he explains: “If you believe that, then you expect that in 2012, the 2001/2003 tax cuts will expire for everyone, and individual income tax brackets will revert back to their 2000 levels.” Tedeschi observes that there is “good reason” to find this assumption “unreasonable.” If he is correct, “then the debt effect of the deal will be more than 6 percentage points of GDP in the long-run, possibly significantly more.” (Tedeschi emphasizes that the views he expresses on his blog are his alone, and not those of the Pew Economic Policy Group.)

I am afraid Teseschi is right. After all, just how likely is it that voters will accept what they are bound to see as a major tax increase if rates revert to 2000 levels? Do you really think that conservatives will graciously agree to give up the tax breaks that are so central to their agenda? Their goal, after all, is not just to lower taxes, but to shrink government. Permanent tax breaks would do just that. Are we certain that liberals will have the majority they would need in both Houses to ensure that the tax cuts are not renewed?

Those who support the Obama-McConnell truce insist that both the payroll tax cut and the income tax break for the wealthy will expire in one or two years. As the New York Times’ David Herszenhorn explained last week-end: “The White House is betting that it will be far harder for Republicans to defend the tax cuts for the wealthy in 2012, when the economy is expected to be stronger.”

But the truth is that the recovery is likely to be much slower than the administration suggests. In 2012 economists estimate 8 percent to 9 percent of all Americans will remain officially unemployed. Writing in the New York Times last week-end, even David Leonhardt, who calls the tax deal “a second stimulus” acknowledged  that: “Initial estimates . . . suggest that the [compromise legislation] will reduce the unemployment rate by one-half a percentage point to a full point over the next year, compared with allowing all the tax cuts to expire and passing no new stimulus.”

In other words, by the end of 2011, we can hope that only 9% to 9.5% of the country will be officially unemployed—plus however many are no longer counted, either because they have given up looking for work, or because they have settled for a part-time job, even though they need a full-time job. (Those two groups are not included in the official unemployment number. When you acknowledge their existence, it turns out that roughly 17 percent of the U.S. labor force is now either unemployed or underemployed.)

Leonhardt continues: “By the end of 2012, the decline could be up to 1.5 percentage points.” That puts unemployment at 8% two years from now. Given the depth of the financial crisis, it could take years to bring unemployment down to the levels we saw in the 1990s.

Here it is important to differentiate between the economy on Main Street and the economy on Wall Street. In 2012, corporations may be reporting fat profits, but unless there is demand for their products, they will not be creating new jobs. “The president’s team is touting the corporate tax break that allows companies to write off investments completely in the next year,” writes Robert Borosage. “But its effect on jobs is likely to be very limited. Companies already are sitting on trillions in cash.” They have the money to create jobs, but not the customers. “Worse still the larger companies are using much of their investment to build plants abroad where markets are growing.” This will not help Main Street.

I am willing to grant that this tax deal may insulate us against a deeper recession. But we need more than that: Washington should be investing in America. Lawmakers should be spending money on infrastructure, education, the environment…This is how government could generate jobs. The demand for workers exists in the public sector where classrooms are crowded and bridges are crumbling. We could add to the wealth of the nation by tending to the people’s business.  But legislation that adds $1 trillion, or more, to the deficit leaves lawmakers empty-handed, killing the chances of a new “New Deal.”

Thus, the economic recovery on Main Street—where most of us live—is likely to be painfully slow. And on Main Street unemployment is not the only problem.  “Home values aren’t recovering, and Americans have only begun to dig themselves out of excessive debt,” Borosage notes. Americans are not feeling wealthy. The years of compulsive consumption have ended.

Meanwhile, the deficit has turned into a shapeless blimp, hovering over the economy. How large will we let it grow? How will we pay it off? Conservatives have an easy answer.  First, let the deficit balloon, then take an axe to entitlement programs.

In part 2 of this post, I will discuss the cost of lower estate taxes, and why this is the part of the deal that is most important to conservatives. I’ll ask whether the President could have gotten a better deal, and why we needed to have a public debate about this bill.  Finally, I’ll explain why this is not “a second stimulus” package, and what it may mean for Medicare, Medicaid and health care reform.