Tax Wars

Obama’s chances for reelection may well hinge on his ability to forge a tax armistice.

 President Obama is fighting a third war in addition to Afghanistan and Iraq. It centers on taxes. In contrast to Afghanistan and Iraq, where Obama has largely adhered to George W. Bush’s policies, he is setting out on a markedly different course when it comes to tax policy. So far, Obama appears intent on using the tax code as a lethal weapon to force the wealthy to cover the expanding federal budget deficit.

The fight, as both the Washington Post and New York Times emblazoned on their front pages yesterday, centers on the Bush tax cuts that were passed by Congress in 2001 and 2003 and are due to expire at the end of the year. Obama says he wants to revert to a marginal tax rate of 39.6 percent. Democrats point to the $2 trillion that will be lost in federal revenues if the tax cuts are extended over the next decade. Republicans, by contrast, argue that failure to extend the cuts will sink an already floundering economy—the financial equivalent of throwing barbells to a man barely keeping his head above heaving ocean waves.

The very top earners could undoubtedly handle an increase in the marginal rate as well as a capital gains tax that rises from 15 percent to 20 percent. But being able to absorb such a hit is different from arguing that it won’t have a profound psychological effect on the top earners. Their purchases have a ripple effect through the economy. If luxury products sold by purveyors such as Neiman Marcus aren’t selling, then not much else is, either. Democrats are kidding themselves when they maintain that allowing the Bush tax cuts to lapse wouldn’t amount to a tax hike. It would. The stock market would plummet to levels not witnessed since it crashed in the fall of 2008.

There are other problems with targeting the wealthy. If you live in Boston, New York, Washington, DC, or other expensive metropolitan areas, it’s hard to maintain that you’re a financial Croesus if you are the breadwinner of a family of four living on a salary of $250,000. The costs of living in such areas are simply exponentially higher, something that Obama never takes into account while, as the president of the Nixon Center, Dimitri Simes, has observed, he sends his two children to the toniest school in Washington, DC, Sidwell Friends.

Another problem is this: why is it that the tax burden is supposed to fall almost exclusively on the wealthy? This isn’t to argue that some measure of progressive taxation isn’t desirable. But it’s no longer progressive, thanks to congressional cowardice. The term “middle class” has become sanctified in American political discourse.

The truth is that the middle class is taking from but not contributing to the nation’s welfare. The numbers are astonishing. According to Scott A. Hodge of the Tax Foundation, the tax code is utterly skewed. Hodge observes:

We now have a record 52 million filers off the income tax rolls. This means 36 percent of all so-called taxpayers actually pay zero in income taxes after taking their credits and deductions. But these figures don't include some 15 million people who work but don't earn enough to file a tax return. When these people are added to the non-payers, estimates the Tax Policy Center, the percentage of households who don't pay income taxes rises to 47 percent.

What will occur in the next year? The optimal outcome would be a compromise between the GOP and the Democrats. The estate tax should be permanently revised to include a $10 million exemption for a couple, the rate of taxation lowered to 30 percent and adjusted for inflation. Democrats will also have to agree to cuts in entitlement programs and the Pentagon budget will have to be trimmed.

The greatest danger would be that taxes are increased without spending cuts. But the co-chairman of Obama’s deficit commission, Erskine Bowles, has sensibly stated that there should be a limit on government spending and revenue of about 21 percent of the gross domestic product. The deficit commission is certain to cause a furor with its proposals when they appear in early 2011.

For now, Democrats and Republicans will be at loggerheads. The optimistic scenario is that each side wants to go into the 2012 election with a real accomplishment. But what if they don’t? As it stands, the estate tax could go from zero this year to a whopping 55 percent next year. In addition, the Bush tax cuts would be rescinded in toto.

Nothing will consume Washington more than debates over taxation and spending in the next two years. For both parties, the stakes could hardly be higher. Obama’s chances for reelection may well hinge on his ability to shun class warfare and forge a real armistice. Which will he choose?


Jacob Heilbrunn is a senior editor at The National Interest.