GREAT BARRINGTON, Mass. - Allowing the Bush tax-cuts to expire could easily be the final nail that seals the coffin of an ailing U.S. economy. Congress should set aside the partisan bickering and extend the cuts.
One thing on which almost all economists agree is that raising taxes slows an economy, increasing unemployment.
When we pay more in taxes we have less disposable income, which reduces consumer demand. So why would anyone consider raising taxes in a barely growing economy with a 9.6 percent unemployment rate? Hasn't the recent recession been painful enough for the American people? Supporters of a tax increase argue that the "rich" were the primary beneficiaries of the original tax cuts and that an increase now would right that wrong.
The problem with such claims is that allowing the tax cuts to expire would raise the rates on the highest-income earners by only about 13 percent - from 35 percent today to 39.6 percent after the increase.
But they also would increase taxes on the lowest-income earners by 50 percent - from 10 percent today to 15 percent. It would be even worse for married couples as standard deductions would be cut in half. To me, this sure looks like a massive tax rate increase on low-income earners.
The increased tax rates and changes in the standard deductions would reduce the disposable income of Americans by approximately $190 billion - making it more difficult for many families to pay their mortgages and food bills.
Reductions in tax credits, like the child tax-credit, would cost families an additional $26 billion or so. Together these burdens would reduce consumer demand, worsen the mortgage default problem, and further depress the housing market. This is not a time to ask families to bear more burdens.
Prior to the Bush tax cuts, business investment had fallen for two years. The cuts reduced the taxes on capital gains and dividends to 15 percent, creating opportunities for investors and lowering costs to firms.
Business investment increased by an average annual rate of more than 10 percent in the three years after the tax cut. The amount of taxable capital gains and capital gains tax revenues doubled between 2002 and 2006. Between 2003 and 2007, total federal tax revenues increased by more than $700 billion. Do we want to discourage business investment in this economy? Another issue is the impact on federal deficits. Many people think that lower tax rates automatically mean that the government collects less in taxes. In fact, the opposite appears to be true: Higher tax rates often slow the economy, reducing tax revenue and increasing deficits.
The U.S. economy, as measured by the gross domestic product, is currently slogging along at a 1.7 percent annual growth rate. The growth rate actually has declined during the last two quarters, leaving unemployment stubbornly at 9.6 percent.
Our research, based on the American Institute for Economic Research business cycle indicators, suggests that the national economy should continue to grow, absent any major policy or tax changes. But the projected low growth rates are not consistent with substantial short-term improvements in the unemployment rate or household income.
Households are still struggling, but the numbers suggest that consumers are starting to spend again. The Federal Reserve has pushed interest rates to the floor already, so monetary policy doesn't have much left to offer.
While there are real signs of hope across the breadth of the economy, the recovery remains fragile and real improvement is going to be slow to come. Asking households and businesses to pay more in taxes right now could jeopardize the recovery.
Steven R. Cunningham is director of research and education at the American Institute for Economic Research (www.aier.org). Readers may write to him at AIER, 250 Division Street, Great Barrington, Mass. 01230-1000.
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