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On tax fight, Obama can't afford to lose

By Steven Pearlstein
Wednesday, July 28, 2010; A10

Barack Obama is at another make-or-break moment in his presidency. The last was when his health-care reform plan was nearly heckled to death at town hall meetings. In the end, health reform was signed into law, as were financial reform and the massive economic stimulus. But the toll for getting them through was so high that the president now faces the biggest challenge of all with his political capital depleted.

That challenge: driving a stake through the heart of the anti-tax monster that has cast a menacing shadow over American politics for the past 30 years. The idea that it is bad to raise any tax on any taxpayer at any time under any circumstances is a pernicious fallacy that is so ingrained in political conversation that it prevents the country from addressing its most pressing problems.

When Senate Majority Leader Harry Reid announced last week, in the midst of record-breaking temperatures, that the Senate was unable to address climate change, it was a capitulation to ideologues and special interests determined to characterize any approach as an energy tax.

It is the refusal to put any tax increase on the table that has impeded much-needed reform of the tax code and rendered impotent a bipartisan commission charged with figuring out how to rein in the budget deficit.

And it is the tax bugaboo that stands in the way of an investment agenda to match the global challenges we face.

If Obama fails to alter the political dynamic and finally slay the anti-tax dragon, it's game over for his economic agenda.

Those are the stakes as Congress now considers what to do, if anything, about the Bush tax cuts that are set to expire at the end of this year. Given the fragile state of the economic recovery as well as the competing imperative to bring deficits under control, the right policy would be to extend the lower rates for another two years while limiting them to lower- and middle-class households. The two-year limit would put pressure on the next Congress to deal comprehensively with deficit reduction and tax reform.

Republicans, of course, are already vowing that they won't support anything less than a permanent extension for all taxpayers, claiming that anything less would be a "massive" and "jobs-killing" tax increase. A few centrist Democrats have already succumbed to the anti-tax pressure.

In reality, raising marginal tax rates on the rich wouldn't be a huge deal. Even Douglas Holtz-Eakin, top economic adviser to John McCain's presidential campaign, told the Senate Finance Committee earlier this month that excluding upper-bracket households from a one-year tax-cut extension would only reduce employment by 300,000 in 2012 and raise the unemployment rate by one-tenth of 1 percent. That's more like statistical noise than the economic calamity conjured up by Republicans.

The reason for this muted impact was explained by two other witnesses at that day's hearing, Len Burman and Donald Marron of the Tax Policy Center.

Marron noted that because of the way the tax code is structured, even the rich would benefit from the lower rates applied to the income they earned under $250,000. Along with other extensions, that would mean that even households with incomes up to $1 million would still get to keep almost half of their Bush tax cuts.

And Burman's point was that spending by rich people wouldn't change much even after a modest tax increase because so much of their income is saved rather than spent. That certainly seems to have been the case when a nearly identical increase in top tax rates took effect in 1994, during another "jobless" recovery. In the ensuing years, personal consumption fell in just one year, and by the end of the decade was growing at the torrid rate of 5.5 percent a year.

Indeed, if Republicans were truly interested in stimulating the economy and creating jobs, cutting marginal tax rates turns out to be one of the least cost-effective strategies. In January, the Congressional Budget Office calculated that $1 million in tax cuts would generate between on and four additional jobs in the economy, compared with six to 15 jobs from increasing unemployment assistance, three to nine jobs from providing aid to states and four to 10 jobs from investing in infrastructure -- all ideas that Republicans opposed as unaffordable. Go figure.

When all else fails, the last refuge for the anti-tax crowd is to claim that raising the top tax rate reduces employment because that is the rate paid by many small businesses -- which, according to Republican myth, create all new jobs. In fact, fewer than 3 percent of tax returns with business income fall into the top brackets. And even for those, it's hard to understand why a profitable company, seeing an opportunity to expand, would forgo hiring because the profits generated by new workers would be taxed at 40 percent rather than 35 percent.

It's not just the economics that favor raising the top tax rate -- so do the politics, according to pollster Peter Hart.

"The public is all in favor of raising taxes on the wealthy," said Hart, who may have sat through more focus groups than anyone on the planet. That would be particularly true, he said, if voters could be assured that the extra revenue would be put to good use, such as reducing the deficit. Maybe it's time to dust off Al Gore's famous "lockbox."

What moderate Democrats need to understand is that it won't do any good to keep playing defense on taxes. There is no thoughtful middle ground on the question of whether to raise taxes modestly on the wealthiest Americans when their incomes are going up and everyone else's are going down, even as budget deficits remain at record levels. The only choice is between political courage and cowardice.

What moderate Democrats need to understand is that if the president loses on this one, there will be no middle ground on anything else they care about, from deficit reduction and tax reform to trade and immigration. At that point, all there will be is stalemate.

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