Tax Analysts Blog

Warner's Solution to the Tax Cut Conundrum

Posted on Nov 17, 2010

You know the story by now. If Congress doesn't renew them by the end of the year, the Bush-era tax cuts will expire and tax rates will return to the levels that existed when Bill Clinton was in office.

That means the top marginal rate on ordinary income would jump from 35% to 39.6%, the long-term capital gains rate would increase from 15% to 20%; and dividends currently taxed at 15% would be characterized as ordinary income and taxed at 39.6%.

President Obama wants to preserve the tax cuts for the bottom 98% of American wage earners; the GOP wants to preserve them for everyone regardless of income level. The issue is likely to dominate the lame-duck session that begins this week.

The GOP reckons our sluggish U.S. economy would suffer further harm if we raised taxes. Increase taxes on the rich, they warn, and the unemployment rate will remain unacceptably high. After all, when's the last time you saw a poor person create a private-sector job?

Not everyone buys the GOP's reasoning, though. The nonpartisan Congressional Budget Office estimates the tax cuts for the top 2% will do little to help with employment.

Still, you've got to give the GOP credit for their clever positioning. They've taken a boring tax issue (which affects a very narrow segment of society) and turned it into a mainstream jobs crusade. And that's likely to be a political winner in this miserable labor market.

But that's not the end of the story.

Enter Virginia Senator Mark Warner, a Democrat known for his pro-business orientation. Warner's column in last Friday's Financial Times introduces a new twist on the tax cut debate. He accepts that the economy must take center stage. Forget those silly notions of social justice and wealth redistribution. This is about jobs, jobs, jobs -- just like the GOP is saying.

So then, what is more likely to reduce the unemployment rate: throwing money at the rich (and then crossing our fingers that it spurs job growth), or spending that same amount of money on more targeted tax breaks for businesses?

Warner proposes that Congress: (i) Retain the tax breaks for the bottom 98% of us; (ii) Allow the tax breaks for the top 2% to expire* as scheduled; and (iii) Take the same amount of money that would otherwise be spent on favors for the top 2% over the next two years -- roughly $65 billion -- and plow it directly into business incentives that are far more likely to create jobs. Those measures might include a more generous R&D tax credit, increased allowances for expensing and depreciation, and -- my personal favorite -- reducing the employer share of payroll taxes for firms that hire new workers.

Not exactly what you expect to hear from most Democrats in Congress. And certainly not what you'd expect from the Obama administration. Tea Partiers could hardly complain; the plan doesn't increase the size of the federal government and the IRS doesn't collect so much as a dime in new tax revenue. The plan merely shifts part of the tax cut from one place to another, where it's far more likely to do some good for the economy.

Warner might just out-fox the GOP at their own game. If this tax debate is really about jobs, as we're being told, then why not cut to the chase. I've yet to meet an economist who disagrees that these business-friendly tax breaks aren't a superior vehicle for stoking job growth than tinkering with the individual rate structure.


[* Note: It's not entirely clear whether Warner would retain the preferential treatment of long-term capital gains and dividends for all taxpayers. Judging from the numbers he uses, it seems the only tax cuts he'd allow to expire for the rich are those relating to ordinary income. We await clarification on that point.]

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