President Obama finally found a tax cut Republicans don't like.
In his State of the Union speech last night, Obama formally, if obliquely outlined his proposal for nearly $200 billion (over ten years) in middle-class tax relief. It includes an expansion of the existing child-care and earned income tax credits, as well as a new $500 "second earner" tax credit for married couples.
Now, it would hardly break Uncle Sam's bank if Obama had chosen not to pay for these tax reductions. They would add just 2 percent to the projected level of debt accumulation over the next decade. That's a rounding error. But Obama did decide to pay for them, by raising taxes on wealthier Americans. He wants to increase the long-term capital gains and dividend tax rates, eliminating a tax break for the "superrich" that allows inherited assets to escape investment taxes, and a tax on megabank borrowing. As Obama put it, "For far too long, lobbyists have rigged the tax code with loopholes that let some corporations pay nothing while others pay full freight. They've riddled it with giveaways the superrich don't need, denying a break to middle class families who do."
The GOP's response has been one of talking-point uniformity, perhaps best encapsulated by a tweet from a spokesman for House Republican budget guru Paul Ryan:
Not a serious plan. We lift families up & grow the economy with a simpler, flatter tax code, not big tax increases to pay for more spending.
— Brendan Buck (@BrendanBuck) January 18, 2015
That analysis is only half right. As political matter, the Obama blueprint is pretty distant from the sort of tax reform most center-right policymakers have been floating. It would add complexity and progressivity, and raise taxes overall. But the basic tradeoff of the Obama plan is perfectly reasonable. One way to raise middle-class incomes is to let folks keep more of their incomes away from the taxman. (An improvement, though, would be to expand the child tax credit to give more families higher take-home pay and more flexibility over their spending. Obama's plan doesn't help households with a stay-at-home parent.) And if you are going to pay the bill for lowering the middle-class tax burden, raising the burden for the rich seems logical during a time when the vast bulk of income gains appear to be going to the top.
But how Obama has chosen to mostly pay for his tax cuts is perfectly dreadful. Raising capital gains tax rates increases the tax code's penalty on savings. Savings, when put to work as investment, boosts productivity and long-term economic growth. And you can't substantially raise middle-class living standards in a slow-growth economy. Redistribution will only get you so far.
There is a strong correlation between venture capital investment and a nation's per capita number of billionaire entrepreneurs. It may be unclear how Paris Hilton's wealth is helping America, but we really do want people starting high-impact startups that may turn into the next Apple or Google or Airbnb — making these entrepreneurs rich in the process. That kind of inequality is good for all us. And if want more venture capital and startups, you probably want to tax investment as lightly as possible. Since 2012, however, we have nearly doubled the capital gains tax rate. Indeed, economic models suggest a tax code that did not tax savings and investment would result in a larger economy. We should be moving the tax code more in a pro-investment direction. The Obama plan does just the opposite.
It also teaches America a terrible economics lesson, something progressives call "middle-out economics." According to this theory, economic growth comes from redistributing wealth from the 1 percent to the 99 percent. The result would supposedly be more consumer spending and faster economic growth. But America doesn't need more "buying power" stimulus as much as it needs a higher growth potential. Right now many economists doubt whether the U.S. economy can grow much faster than 2 percent or so for an extended period vs. the postwar average of over 3 percent. If we want to raise the economy's speed limit, we need more investment in machines, people, and ideas.
So if you still want to raise investment taxes, they should be offset by lower corporate taxes. (A good chunk of the burden of corporate taxes is borne by workers anyway.) Or perhaps raise the long-term capital gains tax rate to the same as that for labor income — then phase it out over four or five years to reward long-term investing over speculation. And there are better "pay fors," such as trimming the state and local tax deduction, a tax break where the 0.4 percent of taxpayers making $1 million-plus reap more than one-fifth of the benefit.
Let's help the middle class, even if it means taxing the rich more. But the Obama plan might make the rich less rich only by dimming possibilities for everyone else.