Now What

01.02.13

After the Fiscal Cliff: What do Democrats Want?

We raised taxes on the rich. Now what?

I wrote on Monday that it wasn't clear to me that Republicans actually wanted any of the stuff they said they wanted in exchange for tax hikes, like entitlement cuts. The Democrats at least had one thing that was politically popular: tax hikes on those who make more than $250,000 a year.  Now they've done it, or at least, gone most of the way there: taxes rise on incomes above $450,000 ($400,000 for singles), while the Bush tax cuts are permanently extended for everyone else. Sure, that means we're raising taxes on only about one half of one percent of the population instead of 2 percent, but that half a percentage point contains most of the obscenely rich people, while exempting the professional class that contains a lot of Democratic voters in high-tax, high income blue states.

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After the House approved the Senate’s fiscal cliff deal late Tuesday night, President Obama sent a message to the next Congress, arguing for a balanced approach to deficit reduction.

Yet Democrats and liberal pundits seem distinctly unhappy.  Partly they're just mad that Obama made concessions at all; apparently, they were expecting that they wouldn't have to, not on anything significant.  But I wonder if there isn't something else to it.  As the saying goes, be careful what you wish for: you might get it.  And then what do you do for an encore?

In a few months, we begin anew the fight over raising the debt ceiling.  Democrats are saying that they must get 1-for-1 new revenue in exchange for any spending cuts.  But do they actually want new revenue?  I submit that just as Republicans are more interested in entitlement cuts as talking points than as actual new laws, Democrats will prove much more interested in tax hikes in theory than in practice.  

For starters, there's a matter of timing.  President Obama just successfully raised taxes on the rich. Is he going to go back and do it again in a few months?  I'm not sure about the optics here: while I think that a tax increase on the rich was popular and inevitable, I don't think that Democrats will do well to position themselves as the party that does nothing but demand more tax increases, even on rich people.  Moreover, each successive tax increase is likely to be less popular than the last, precisely because the most politically popular increases inevitably get passed first.  A return to the Clinton-era tax levels on people who make more than $450,000 a year is, politically speaking, a no-brainer.  A further hike will peel off a few voters who just wanted the rich to pay their "fair share" and now feel content.  The third hike will be pushing rates close to 50%, if it is to raise any money at all.  That seems to be pushing pretty far past most Americans' ideas about what tax rates ought to be.  

Now consider the potential alternative sources of extra revenue.  Which of these do Democrats actually want to do?

1. Limit personal income tax deductions: In theory they're totally in favor of getting rid of loopholes.  In practice, they're maybe willing to attack the carried interest deduction for hedge fund managers, but this raises a trivial amount of actual cash for federal coffers. All the real money is in the the child tax deduction,  various educational deductions and credits, the mortgage interest tax deduction, the charitable deduction, and the deduction for state and local income taxes.  Touching the first is political suicide, and touching the rest is a slightly more exotic form of political suicide.  Ending the state and local income tax deduction would create instant political pressure to shrink blue state government, and also of course be bad for blue-state taxpayers.  The mortgage interest deduction also disproportionately benefits blue-state homeowners whose homes sit on expensive land.  Educational tax credits are also a boon to various Democratic constituencies, including educational workers.  And nonprofits are a very liberal sector that many policymakers and legislators move in and out of.

2. End the tax-free status of municipal bonds: As with the personal income tax deduction, I have no doubt that there are Democrats who think they want to end this.  This is, after all, the gimmick which allows folks with the wealth of a Theresa Heinz Kerry to pay approximately the same effective tax rate as a single mother payroll clerk.

But if local borrowing costs go up, we get less local government, which Democrats like, and fewer government workers, who are heavy supporters of both Democrats, and the Democratic Party

3. End the tax-free status of employer health benefits:  So many problems with this, I think we can all agree it's a nonstarter.  Beyond the obvious outraged backlash this would cause, this would also encourage employers to drop health insurance, kicking more people onto the exchanges, where a lot of them would pick up federal subsidies.  

4.  Trim the EITC:  Technically a revenue source, and a substantial one, but not one I see Democrats getting on board with.  Nor, as a policy matter, do I think they should: work-based poverty policy is exactly what we should be focused on.

5.  Value Added Tax:  Huge revenue-raiser, which is why Republicans hate it. Value added taxes are very hard to dodge, because it's largely self enforcing: if you don't pay the tax, the people you sell to have to pay it, so they tend to demand proof you've paid.  Unfortunately, as with all sales tax variants, it's hard to make the thing progressive; exempting "necessary" goods and services only gets you so far.  So it's not very popular with Democrats, either.  We may end up with a VAT, but only when we're really desperate.  

6. Carbon tax: I would support a carbon tax even if we didn't need the money, because global warming is a real problem.  But I live in a lovely rowhouse in a walkable urban neighborhood.  Most people do not, which is why cap and trade failed spectacularly; pricing carbon is wildly unpopular outside of a handful of dense urban cores.  To be sure, a lot of people live in those dense urban cores, but altogether the walkable bits of New York, Boston, Philadelphia, Chicago, San Francisco and Washington account for less than 5% of the United States population.

7. Stiffer corporate income tax:  This one I imagine Democrats would like to do.  But as I said earlier, you need to look at actual mechanics, rather than thinking about this in the abstract.  What deductions shall we get rid of?

When you look at the actual proposals Democrats talk about, they're trivial.  Things like lengthening the depreciation schedule for corporate jets, which doesn't raise much in the short term, and raises almost nothing in the long term, because while companies get a smaller depreciation and amortization deduction for the first few years, that just means they get a bigger one later.  Or ending the immediate expensing of drilling costs, a deduction that the major oil companies lost years ago, so that you're basically just pulling pennies out of wildcatters.  

You don't see many of them suggesting that we should, say, end the deductibility of debt interest payments.  And I presume that the reason they do not suggest this is that doing so would disadvantage large manufacturing firms, the kind that pay high wages, often to union workers.  It might also put a bit of a crimp in the economies of states like New York and Delaware.  

Overall, I don't see a lot of Democratic enthusiasm for further actual tax increases.  I see a lot of enthusiasm for "raising taxes on the rich" as a theoretical construct which, like "American exceptionalism", can be vigorously waved in speeches and then put back in the vault for safekeeping as soon as everyone's seen that you're the right sort of person who believes in good things.  

The problem, of course, is that Democrats want a big government that does a lot of things.  For the past few years there's been a widening disconnect between the tax cuts that Republicans say they want, and the spending cuts they are willing to actually deliver.  Having achieved the tax hikes on the rich that they campaigned on, Democrats are not in exactly the same boat--but it does look pretty similar.  They want a big government with a generous welfare state, and a tax base that's about half the necessary size.

This doesn't make me happy, by the way.  It was grossly fiscally irresponsible to make most of the Bush tax cuts permanent, rather than temporarily extending them until the economy gets stronger.  Both of our parties seem increasingly detached from fiscal reality, perhaps because most American voters have themselves moved to la-la land, where we can have a balanced budget, no tax increases except on the rich, and no spending cuts except in foreign aid.  Luckily for us, so far the bond market seems to be vacationing there as well.