The Tax Trap

I would like to claim credit for this idea, as I espoused it among friends long before I heard it on the radio.  In reality, before writing it I heard it on my daily ride home in the brief segment of the Sean Hannity Show that I listen to before getting annoyed with Sean it and changing to my music station.  I have expanded upon what the caller in to the show stated.

There is a problem with any temporary tax rate extension.  Right now, the Senate is debating an extension to the current tax rates (which the Left lovingly describes as the “Bush Tax Cuts”) while House Democrats have already rejected that bill out of hand.  The bill is to extend the current rate for an additional two years, essentially putting the onus on the next Congress to extend said tax levels any longer.

Conservatives are enamored with the Laffer Curve, the theory that a reduction in tax rates will result in an increase in investment, spurring economic growth and, by extension, greater tax revenues despite the lower tax rates.  The evidence is that Laffer’s curve theory is in fact true, since historically major tax cuts have always, over the long term, resulted in equal or greater tax revenue as during the previous higher-tax regime.  Liberals hate this.

So as Conservatives espouse the advantages of the Laffer Curve, the President has offered a “compromise” wherein conservatives give him lots of pork spending and other Leftist goodies, while the tax rates are extended for a scant two years.  The Senate Republicans, eager to get the tax rates extended and “prove” the Laffer Curve (as well as to make sure everybody’s tax withholding doesn’t go up on January 1), enthusiastically support the bill.

Dumb move.

The problem with this is the length of the extension:  Just two short years.  Had a two year extension been approved in 2008, it might have helped to stimulate our economy and settle corporate jitters, eliminating some of the economic mess we’re now facing.  Sadly, President Bush and the Democrat Congress instead chose to spend billions of dollars forcing banks to take money they didn’t need.  In 2009, President Obama and the Congress chose to spend billions more dollars on pork projects and patronage, and yet again punted the tax cuts until after the election in 2010.

A two year extension now is too little, too late.  Instead of helping to calm the fears of corporate managers, all the President and Congress will do is continue the economic malaise.  Corporations will have a bit more certainty, but not much.  Most businesses don’t invest expecting a two year return.  Smart busineses plan on at least a five year scale, if not longer.  Extending tax rates for two years only clears up uncertanty for the near term.  It makes it less likely people will lose their jobs to layoffs next year, but doesn’t encourage new investment in new plant and equipment with a ten-plus year payoff period.

The United States already has the second-highest tax rates in the developed world (the highest rates in some high-tax states).  An extension of the tax rates merely means we choose to not be the most hobbled runner in the economic rat-race.  A short-term tax rate extension, to continue the metaphor, means we’re running around the track with cement in our shoes and a basket over our shoulder waiting for somebody to dump sandbags in it.  The only reason we’re still running in front is because we’re already the strongest runner in the group, but those guys China and India are fast catching up!

The goal of the Republicans should be a permanent extension of the current tax rates.  Settling for a two year extension is poor policy:  When the extension doesn’t work to stimulate growth, the Democrats will be able to demonize it.

SEE?! SEE?! The Laffer Curve doesn’t work! Those AWFUL Republicans lied to you! Vote for us! Stop the tax cuts for the filthy, awful rich and vote for US!!!!

And the voters, generally ignorant of anything more than the most basic economic ideas, will believe them. Because, as far as they will be able to tell, the tax cuts won’t have worked to stimulate the economy. The short-term nature of the cuts will have played right into the hands of the President and the Democrats. While the Left may, in the short-term, be apoplectic over the President’s deal with Senate Republicans, in the end it will end with Democrats having a seemingly strong case for a continuation of their economic policies and a rejection of the Republicans.

Sun Tsu wrote, “By holding out advantages to him, he can cause the enemy to approach of his own accord; or, by inflicting damage, he can make it impossible for the enemy to draw near.” President Obama has offered an advantage to the Senate Republicans, allowing them to draw near to the trap illustrated above.

Republicans in both houses of Congress would be smart to refuse it.