We have two temporary tax cuts. One is on federal income taxes; it’s been around for 10 years and has benefited upper incomes much more than anyone else. The other temporary tax cut is on payroll (Social Security and Medicare) taxes and went into effect a little more than a year ago; because there is a cap on how much income is assessed for the payroll tax, this temporary tax cut has put money primarily into the pockets of the poor and middle class.
Our elected officials are now taking a close look at ending or extending these temporary tax cuts, especially in light of the almost universal desire to balance the budget and to jumpstart the economy and create new jobs.
President Obama and many Democrats want to extend the payroll tax cut and end the income tax cut for higher incomes. The Republicans want to do just the opposite: to restore the payroll tax cut while keeping the income tax cuts for the wealthy. No one seems to want to touch the temporary-for-10-years income tax cut on middle and lower incomes.
Both give the very same reasons for their proposals: We can’t end the tax cut we like because it will hurt the economy, but we have to end the tax cut we don’t like to help pay down the deficit.
Who is right and who is wrong?
Republicans say that it’s the rich folk who invest in businesses that produce jobs, so we better not limit their ability to do so by taking money from them. Let’s examine this idea in light of current business practices. Before making any investment that produces jobs, a company or individual analyzes the marketplace, seeking to answer one question: is there a need or can I readily create a need for this product or service in this market? If no market exists, the company and business doesn’t make the investment. If there is no investment to make, they’ll raise salaries, usually for executives only, and pay out dividends. This additional wealth will end up driving up stocks, luxury goods and artwork, which creates little if any new jobs. In a slumping economy, there is by definition less reason to invest, since fewer people have money to spend.
By contrast, virtually all of the additional money the poor and middle class have received from the temporary payroll tax cut has been spent and will continue to be spent, thus maintaining or increasing demand for a wide range of goods and services. Businesses will retain or create jobs to meet that demand, even if they end up paying more in taxes, because they’ll be making more money. As Warren Buffet recently pointed out, people and companies don’t avoid making more money as a way to avoid paying additional taxes. High taxes or low, they’ll want to make the money.
Thus, without considering any issues of fairness or equity, it makes more sense to extend the temporary payroll tax because it will at the very least continue demand. But it makes no sense to continue to extend the 10-year tax break for the wealthy, since unless there is greater demand from the general public, they will likely not use the extra money to create jobs; and if there is demand from the general public, not having the tax cut will not serve as an impediment to additional investment.
The Republicans have it entirely wrong, then, that is, if we assume that they are truly interested in righting the economy and creating more jobs. If, on the other hand, their true interest is to use tax policy and government spending to shift wealth to their top contributors, i.e., the wealthy, then their proposal to end the payroll tax cut while continuing the income tax cut for all incomes makes perfect sense.