With proposals for higher taxes, debates over a record deficit and the prospect of higher interest rates, forget about politics as usual. If anything, this election year seems to be producing politics unusual.
Sen. John Kerry (D-Mass.) wants to repeal of the Bush income tax cut for Americans earning in excess of $200,000 a year. Taxpayers at that income level would see their tax rate increase from 35 percent to 39.6 percent. On earnings of $400,000 the repeal would mean an additional $18,400 tacked on to an already hefty $140,000 federal tax bill. Add state and payroll taxes of around another 10 percent, and our taxpayer will owe $198,400 of the $400,000 to the government. Kerry reasons that these earners should pay more of their income in taxes because they can afford it.
President Bush and the Republican-controlled Congress argue that these higher earners will use the funds not spent on taxes for investment in their business or stocks which will support the US economy and create jobs.
This is not a simple debate of the moral and economic implications of the tax code. There are several complex issues intertwined with this tax debate:
- The US is running a record deficit in excess of $500 billion per year. A deficit means expenses exceed revenue. A tax hike will increase revenues.
- The tax cut provided fiscal stimulus while the Federal Reserve created monetary stimulus in the form of lower interest rates to bring the US economy out of recession. As the economy recovers and begins to rebound, the liquidity created by these interventions must be delicately reversed to prevent a surge of inflation. A tax hike will reverse the liquidity supply, but limiting the tax hike to the elite, $200,000 and up crowd won't help very much.
- A broader increase in taxes would offer a more immediate reduction to liquidity and a more significant impact on the deficit, but no candidate will suggest really raising taxes before an election. The fat, over-$200K crowd is always a safe target for a candidate searching for the middle class vote.
The White House argues that tax cuts have already helped the economy on its recovery trail. Maintaining lower rates, administration officials say, will maintain higher Gross Domestic Product growth, and as GDP increases, the deficit as a percentage of GDP will become less and less significant. For example: if you have a $200,000 mortgage on your $400,000 home, your debt (deficit) is 50 percent. As the real estate market improves and the value of your house increases to $600,000, your $200,000 mortgage now represents a less significant 33 percent debt (deficit). You aren't growing yourself out of debt; but your financial statement is showing dramatic improvement.
The U.S. deficit is at a record high: Expenses are well ahead of revenues. The simple solution is to cut spending and raise taxes, but it's not as easy as it sounds.
Reducing spending is extremely difficult while a country is at war, engaged militarily in several theaters, and facing the additional problem of homeland security. Thus, while some spending cuts are certainly possible, large reductions are not.
Raising taxes is always possible, but tax increases during the genesis of economic recovery can't be sweeping or the economy could be stalled and thrown back into recession.
My take is that:
- Tax hikes, if necessary, should wait. The economic recovery is still too fragile.
- Monetary policy should be the first tool in holding inflation at bay. Federal Reserve Chairman Alan Greenspan knows how to raise interest rates, and he will do it when the time is right.
- Targeting big earners for a tax hike seems politically expedient and of little real economic value.
- The current 5.6 percent unemployment rate has long been considered to be full employment and is acceptable. Yes, everyone would like job growth, but it is not an economic necessity at this juncture. I can say so because I'm not running for anything.
- Shrinking the deficit as a percentage of GDP is a nice theory, and it may work -- but higher taxes may be necessary if it doesn't.
Protecting the United States took on new and complex consequences after Sept. 11, 2001. Bottom line: It became much more expensive for the country to carry on with its chosen lifestyle and liberties. More money is necessary to cover those expenses. Other spending cuts and sacrifices will be necessary to afford this mandatory increase in our national defense.
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