Marketplace of Ideas Blog

The Obama administration (which does not face elections until November 2012) and Senate Democrats (who face elections in three months) appear to have different opinions about the tax cuts that expire this year.

First, the view from 1600 Pennsylvania Ave.:

Treasury Secretary Timothy Geithner said the Obama administration will allow tax cuts for the wealthiest Americans to expire on schedule despite calls from a small but increasingly vocal group of Democrats to delay any tax increases.

Mr. Geithner said the White House will allow taxes on top earners to increase on Jan. 1, 2011, as part of an effort to help bring down the mounting budget deficit. He said the White House still plans to extend tax cuts for middle- and lower-income Americans and expects to undertake a broader tax overhaul next year.

“We believe it is appropriate to let those tax cuts that go to the most fortunate expire,” Mr. Geithner said at a breakfast with reporters, hosted by the Christian Science Monitor.

Next, the view from East Capitol Street Northeast and First Street Northeast:

Two more Senate Democrats called for extending tax cuts for all earners—including those with the highest incomes—in what appears to be a breakdown of the party's consensus on the how to handle the expiration of Bush-era tax cuts.

Sen. Kent Conrad (D., N.D.) said in an interview Wednesday that Congress shouldn't allow taxes on the wealthy to rise until the economy is on a sounder footing.

Sen. Ben Nelson (D., Neb.) said through a spokesman that he also supported extending all the expiring tax cuts for now, adding that he wanted to offset the impact on federal deficits as much as possible.

They are the second and third Senate Democrats to come out publicly in recent days in favor of extending all the tax breaks for the time being. Sen. Evan Bayh (D., Ind.) made similar comments last week.

This tax increase is on top of the rebirth of the estate tax in 2011 as well. Both of these, of course, affect readers of Marketplace. The debate over both expiring tax cuts will particularly make the Seventh and Eighth Congressional district races interesting, as well as the U.S. Senate race featuring supposed maverick Sen. Russ Feingold (D–Wisconsin).

But is it an issue of continuing tax cuts or cutting the deficit? Well, no, because, according to the American Enterprise Institute’s Andrew Biggs, taxes will increase anyway:

As I argued in the Wall Street Journal in 2008, the income tax code is inadequately indexed for the growth of incomes. The income tax brackets — the dollar amounts that designate the tax rates that apply to an individual’s income — are indexed only for inflation, while incomes tend to rise about 1 percent faster than inflation each year. The result is that a greater and greater share of individuals’ incomes will fall into higher tax brackets, increasing taxes even if the formal tax rates remain the same.

The effects of this are larger than you’d think. According to Congressional Budget Office (CBO) data, individual income tax receipts averaged 8.15 percent of Gross Domestic Product from 1953 through 2008. Due to the recession, this year they’re projected to equal around 8 percent of GDP.

But by 2020, income tax receipts are projected to rise to 9.5 percent of GDP, even if all of President Bush’s tax cuts are made permanent. By 2030, income tax receipts will rise to 10 percent of GDP, 22 percent higher than the historical level.

A greater and greater share of individuals’ incomes will fall into higher tax brackets, increasing taxes even if the formal tax rates remain the same.

Put another way, the CBO reports that in 2007 the average household paid 9.3 percent of its income in taxes. Obviously, this average masks a tremendous variation between income levels, and households pay payroll and other taxes as well. Nevertheless, we can roughly estimate that the average household income tax rate will rise to 10.4 percent by 2020 and 10.9 percent by 2030. Average marginal rates — the rate paid on an additional dollar of earnings — will also rise.

In other words, we don’t have to talk about tax increases, we’ve already legislated them. If tax increases of this magnitude were proposed explicitly, there’s little chance they could pass Congress. But such a proposal would be helpful, since it would focus the public’s mind on the size and responsibility of government relative to individuals.

Yet, over time taxes will rise through simple inertia. And if the Bush tax cuts for high earners are allowed to expire, then tax revenues will rise further.