US tax hikes: Instant austerity may not be the best answer. If the US Congress doesn’t act, tax cuts from 2001 and 2003 will expire at year’s end. But with unemployment high and growth sluggish – and borrowing still easy for the US government – there’s a case, as with expenditure cuts, for waiting for better economic times.
Figuring out what to do about taxes is among the biggest remaining items on the congressional docket. And time is running out before the November midterm elections. Taxes also have more immediate resonance with voters than other agenda items such as immigration and climate change.
Democrats want to let George W Bush’s income and investment tax cuts expire next year for the rich but extend them for the middle class - at least for a while. That seems to be President Barack Obama’s preference, too. But Capitol Hill is currently obsessed about balancing the books. Legislators have been squabbling over how to pay for a mere $34 billion in extra unemployment benefits. Good luck finding $350 billion in other revenue or cost cuts to offset, say, a two-year extension of the tax cuts.
The trouble with letting all the tax rates return to the levels prevailing under Bill Clinton would be the braking effect on the only slowly recovering US economy.
A Goldman Sachs study, for instance, predicts a three percentage point drop in GDP in 2011 under that scenario. The other option for Congress is simply to swallow hard, extend the tax cuts, add the lost revenue to the deficit, and borrow to cover that. The politics might work. Few Democrats want to be seen raising taxes right before an election, especially coming out of a recession. And Republicans care less about deficit-financed tax cuts than about deficit-financed government spending.
There is reason to think financial markets would let Uncle Sam get away with it, too. Bond yields reveal little near-term debt fear on the part of investors. And annual federal debt interest payments stand at just 1.5 per cent of GDP. Of course, the danger of deferring austerity is that desperately needed spending cuts and/or tax increases won’t get the requisite attention. But for right now, making sure the tentative recovery doesn’t expire is the top priority.
