If Congress cannot reach a compromise to extend the Bush tax rate cuts and a political standoff results in taxes going up for everyone on Jan. 1, the already anemic economic recovery will be in grave jeopardy. The earlier this issue is resolved, the sooner taxpayers can know their expected 2011 tax bill and adjust their spending accordingly.
Recognizing this, both the Republican and Democratic parties agree on extending tax cuts for those making less than $250,000. The contention concerns those making incomes above that cutoff. In their effort to get the extension for high-income earners, Republicans seem willing to hold up the extension for all.
The objection against extending tax cuts for the "rich" is that they have a smaller "economic multiplier effect," that is, they save much more of each after-tax dollar than those in lower income brackets. Consequently, each dollar of their tax cut results in less job creation and economic stimulation. Moreover, a portion of their savings goes to investments out of the country. Consequently, extending the tax cut for this group is regarded as too much deficit reduction foregone for too small a boost to recovery.
We cannot afford a prolonged debate. Despite postelection rhetoric to the contrary, a solution on extending the Bush tax cuts for everyone is possible without either side losing face and with the added benefit of being able to fund much-needed infrastructure repairs. Recessions are a good time to repair infrastructure since this activity creates jobs in the short run and provides long-lived capital to support rapid growth when recovery comes.
Our proposal: A win-win solution
Extend the Bush tax cuts for all income levels, but treat the tax cut extension for incomes above $250,000 in a special two-part way.
First, tax earned incomes above $250,000 at 2001 rates.
Then, in exchange for these higher tax payments, give those "rich" taxpayers government bonds maturing no less than five years from their tax payment date. The par value of bonds received would equal the dollar value of the extra taxes paid, and the coupon would reflect current market rates.
Second, use the cash generated by the extra tax payments to create a National Recovery and Reconstruction Fund earmarked to improve our crumbling infrastructure.
Those making less than $250,000 per year win because they continue to be taxed at the lower Bush rates. High income earners, the so-called "rich," are indeed singled out for special treatment, but they are winners as well. They will realize their tax cut when they redeem or sell their "National Recovery Bonds," and during the interim, their money is earning interest.
The nation wins by putting these "forced savings" dollars to work creating jobs and improving the physical infrastructure of the country. The economic multiplier effect of this investment will help accelerate our economic recovery and, through modernization and repair of national infrastructure assets, support economic growth when the recovery comes.
Much has been made of the "cost" of extending the tax cuts for all taxpayers. The Pew Economic Policy Group estimates that lost government tax revenues would amount to more than $3 trillion in the next 10 years. However, this calculation is a "static scoring" model that simply multiplies taxpayer income by the proposed change in tax rates. It does not consider the cost to the economy resulting from resources that remain idle and skills that erode through disuse.
We are in the midst of a steep recession, and the goal is to return to full employment. Failure to extend these tax cuts will harm the economy for an unknown period into the future. Through the use of National Recovery Bonds, the economy gets a large stimulus with little or no additional cost since the borrowed money will be used to create productive assets of lasting value, which will enable the recovery, when it finally arrives, to be more robust.
Charles O. Kroncke is associate dean in the University of South Florida College of Business. William L. Holahan chairs the Department of Economics at the University of Wisconsin-Milwaukee.