With Obama leaving his Hawaii vacation for Washington Wednesday evening and lawmakers returning Thursday, the main dividing line between Republicans and Democrats has come down to whether tax rates should increase for top earners at the end of the year, when the Bush-era tax cuts are set to expire. While Republicans want to extend all the cuts, Democrats are pushing to maintain lower rates on household income below $250,000. Those lower rates significantly reduce the taxes of nearly all American households that earn less than $250,000 — and many who earn more, even if tax rates are allowed to increase on income above that figure.
While it is increasingly unlikely that the two parties will reach an agreement to avoid the fiscal cliff before Jan. 1, it is all but certain that their ultimate deal, whenever it comes, will make permanent the lower rates for most Americans.
R. Glenn Hubbard, dean of the Columbia Business School and an architect of the Bush tax cuts, said it is “deeply ironic” for Democrats to favor extending most of them, given what he called their “visceral” opposition a decade ago. Keeping the lower rates even for income under $250,000 “would enshrine the vast bulk of the Bush tax cuts,” he said.
Democrats say they have reconsidered their opposition to the Bush tax cuts for several reasons. The cuts were written into law from 2001 to 2003 after a decade in which most Americans saw robust income growth. Over the past decade, by contrast, median wages have declined, after adjusting for inflation, amid a weak economy. Allowing tax cuts for the middle class to expire would further reduce take-home pay.
“We’ve had these tax cuts in place since 2001. The world changes, and the economy is where it is,” said Steven Elmendorf, who was chief of staff to former House minority leader Richard A. Gephardt (D-Mo.), a primary opponent of the Bush tax cuts. “With people’s economic status, we should not be raising taxes on people earning under $250,000.”
What’s more, income inequality has been growing. Sparing the middle class higher taxes while requiring the wealthy to pay more would tip the scales slightly in the other direction.
“The reason there’s been this movement toward broad consensus on renewing the tax cut for working- and middle-class families is that will give us a sharper progressivity in the tax system that is very much desired by Democrats and progressives who’ve seen an income distribution more and more distorted toward the wealthy,” said Betsey Stevenson, former chief economist in Obama’s Labor Department and a professor at the University of Michigan, who added that taxes may have to rise even more than currently contemplated to meet the country’s needs.
But more than economics is at work. Democrats have found what they consider a winning political argument in calling for lower taxes on the middle class and higher taxes on the wealthy. And while, a decade ago, many Democrats favored maintaining higher tax rates to help fund domestic programs, it is much harder to take away a tax cut than make it.
“Most fundamentally, it was due to a perception by Democrats that the political reality was moving to the right on economic policy,” said Jim Manley, a former top aide to Senate Majority Leader Harry M. Reid (D-Nev.). “The Democratic Party has adjusted to those realities and recognizes you’ve got to be more careful about focusing on the middle class.”
Even as they agree that taxes shouldn’t rise on the middle class when the economy is still weak, some liberals are worried by the prevailing Democratic view that the bulk of the Bush tax cuts should be made permanent. Liberals fear that lower revenue means less money for domestic programs, such as education, as well as for the social safety net.
The Bush tax cuts involve a long list of provisions, including lower federal income-tax rates for all Americans, lower tax rates on investment income such as capital gains and dividends, and tax benefits for married couples with children. The scheduled expiration of the Bush cuts, combined with an end to other temporary tax cuts enacted more recently by Obama and deep spending cuts, constitute the fiscal cliff, which is to take effect in January barring action by Congress. These dramatic fiscal changes could tip the U.S. economy back into recession.
Although primarily targeted toward households earning less than $250,000, the middle-class component of the Bush tax cuts also benefits those earning above that. The first $250,000 earned by even the wealthiest families is subject to lower rates. For this reason, Obama noted last month that under his proposal, “every American, including the wealthiest Americans, gets a tax cut.”
For instance, an individual taxpayer earning between $200,000 and $500,000 a year would pay an average of $515 more in taxes next year if the Bush tax cuts for the wealthy expire, according to the nonpartisan Tax Policy Center. But if all the Bush tax cuts were to vanish and the rich had to pay higher rates on all their income, their tax bills would shoot up by an average of $6,000. The very richest — the top 1 percent of earners — would pay much higher taxes if solely the upper-income tax cuts expire, because the savings from extending the rest of the rates would be relatively negligible.
In 2001, when Bush proposed the tax cuts, Democrats argued they would benefit the wealthy, create long-term deficits and deprive social programs of needed money. Some Democrats at the time were open to a more modest tax cut, especially one less favorable to the rich. Bush could push his tax cuts through Congress only by agreeing they would expire a decade later.
Under GOP pressure, Obama renewed them in 2010. He has vowed not to extend the upper-income tax cuts again. He is also demanding that at least $400 billion worth of tax breaks for the wealthy be eliminated to further reduce the deficit.
As Democrats warned a decade ago, the benefits of the Bush tax cuts have disproportionately flowed to upper-income earners, according to economists. The tax cuts, however, have also benefited less-fortunate Americans, slashing taxes for many low-income households and creating new credits to lighten the financial load of raising children.
The Democrats were also correct in warning about the effect on the government’s debt. The tax cuts did more to fuel ballooning federal deficits over the past decade than any other Bush administration action — including the wars in Afghanistan and Iraq and the creation of a prescription drug benefit for seniors, according to the Pew Fiscal Analysis Initiative. And in coming years, the Bush-era tax cuts are projected to expand the deficit by trillions more.
“The bulk of the [tax cuts] is baked into the cake, and we don’t talk about that. From a fiscal and economic policy standpoint, it makes no sense,” said Bob Greenstein, president of the left-leaning Center on Budget and Policy Priorities and a White House ally. “I don’t see how you can go into future decades with these tax cuts.”
But it’s not clear whether they took a toll on funding for social programs. Bush, for instance, created the new Medicare prescription drug benefit through increased federal borrowing.
GOP thinking about the tax breaks has also shifted over the past decade. While long the party of tax cuts, Republicans justified the Bush cuts largely in terms of refunding projected budget surpluses that emerged about a dozen years ago. “A surplus in tax revenue, after all, means that taxpayers have been overcharged,” Bush said in 2001. “And usually when you’ve been overcharged, you expect to get something back.”
But today, even though the budget is in far worse shape, Republicans defend the Bush tax cuts as helping the economy.
“It’s completely different today,” said Steve Bell, a former senior GOP budget staffer in the Senate. “Back then, we were thinking we had all this extra money.”