Saturday, December 18, 2010

Political Economics vs. Political Compromise

The politically controversial tax cut compromise between the Republican Congressmen and the Obama Administration was passed by both the Senate and House of Representatives and immediately signed by President Obama this week.  The components of this bill and the rush to compromise have deeply divided the Democrat Party and made Deficit Hawks public hypocrites.  Despite the heavy political pressure brought on Democratic Senators and Representatives to vote for this compromise, there were big names voting no, particularly in the House

President Obama's willingness to compromise was seen by sincere and ardent supporters as a recognition of political reality and the need to continue extended unemployment benefits, by moderates as a President who is getting bad economic and political advice, by conservatives as a mockery of deficit reduction, by liberals as a cave in to the special privileges of the wealthy and a hidden threat to the future of Social Security, and by economists as a bill whose cost exceeds TARP with primarily one-to-two year very limited and ineffective stimulus and continuation of 2010 policies which is not targeted, timely, or temporary.  President Obama has consistently received bad economic advice throughout his Administration as I and many others have documented.  President Obama has shown a willingness to compromise which has yielded political victories but not yielded effective policies, such as the substantially flawed universal health care bill and the significantly too small and too slow economic stimulus bill, which has left us with a lingering too slow growth and too high unemployment with no visible horizon.  While President Obama has shown a lack of knowledge with respect to economcs and history, as most recently demonstrated by his misrepresentation of the beginning of Social Security, he is facing a political opposition which seems more intent on political positioning than a consistent policy with respect to deficits and eager to ignore or rewrite history, particularly assigning  the Bush economic advisers admissions that the Bush tax cuts were not economically effective to oblivion.  President Obama has been consistent in his legislative support of business and financial sector interests at the expense of families needing food stamps ($2.2 billion in future SNAP cuts) and failure to provide job programs now (ensuring high unemployment for up to the next election if not longer) or otherwise stimulate aggregate demand.  His intent, despite promises and public opinion,  to continue the Bush tax cuts for those making more than $200,000 - $250,000 were publicly known and the political opposition holding the expiration of extended unemployment benefits hostage was a convenient excuse for which he was happy to not enunciate the hypocrisy of the deficit hawks pushing a proven deficit growth vehicle pandering to the the top 2% most wealthy  of the population which the political opposition want to make permanent.

Barney Frank voted against the bill saying there were no offsets to the continued tax cuts.  The expectation is that Social Security funding will be cut in the future to pay for the Bush tax cuts to the wealthy.  In fact, the payroll cuts reducing social security taxes for both employee and employer by 2% was the Administration's idea and it will be less economically stimulative than the Making Work Pay program it is replacing as well as not increase output or demand..  While that is not a direct threat to Social Security, it is an opening for a reduction in the social security program, which social security advocates and many economists seriously consider a possibility.  With a one year expiration, the payroll tax is presenting the political opposition with another hostage situation and an opportunity to reduce social security a year from now.  The payroll tax, itself, does not threaten social security solvency; it is regressive by not taxing higher incomes as much; it is designed to dampen consumption by wage earners to leave some for retirees; it technically does not fund social security but this is not widely understood.  I have never understood why all earned income is not payroll taxed at the same percentages.  There are those who do understand how the payroll tax really works who would do away with it entirely and substitute it with a tax on all income, earned and unearned. If this were a flat tax without privileged exemptions or deductions (i.e., not income variable or available - for all practical purposes - to a few), it should yield more tax revenue than a progressive tax and significantly reduce the tax code to a few pages and the cost and size of the Internal Revenue Service.

While the political threat to Social Security is real, the House Democrats were more concerned about the estate tax exemption going to $5,000,000 per spouse and the tax rate going down to 35%.  They wanted to revert back to the 2009 level of $3,500,000 and 45%.  The higher exemption and lower tax are seen as providing for the privileged wealthy while the ordinary folk will just have to make do in this economy.  It sets up an election year issue with its two year expiration just as the Bush tax cut extensions do.  It also creates a tax choice for estates in 2010, because there will now be a choice between the 2010 no tax but a same basis as the decedent or the new but effective for 2010exemption and tax with a stepped up basis; in many cases the wealthy beneficiaries will choose to pay the tax.  If nothing had been done, the estate tax for 2011 would have reverted back to the pre-Bush tax cut amount of $1,000,000 exemption and tax of 41%-55% and a 5% surtax on $10,000,000 up to $17,184,000.  The $5,000,000 exemption and 35% tax were exceptionally large benefit increases for the wealthy and a lost opportunity for tax reform.  Much is made of family farms and the estate tax, but farm estates pay the estate tax over a fourteen year period and this has not been changed.  The problem with farm estates is that the estate plan has not been properly constructed to be viable for that family and/or the vehicle of the estate plan, such as a family limited partnership, has been defectively operated.  Small business estates usually suffer from no viable business succession plan or no funded business succession plan. 

The much ballyhooed 13 month continuation extended of the unemployment benefits does not extend benefits beyond 99 weeks, which means those unemployed longer than 99 weeks are social refuse.  Despite continued fallacious arguments that unemployment benefits discourage job seeking, unemployment benefits have been shown to improve employment and to be economically stimulative, but the stimulus here is old stimulus and not new stimulus, which means no new, only continued except for no checks going to those over 99 weeks, economic growth resulting.

Most public discussion has been based on a broad tableau.. In more detail, the gift tax is unified with the estate tax, which means there is a lifetime gift tax exemption of $5,000,000 on top of the annual $13,000 exclusion.  If the $5,000,000 estate exemption is not used, the remainder, under this new law, will be available to the surviving spouse to shelter either lifetime gifts or estate tax.  Numerous tax credits are continued which had expired, such as charitable contributions from IRAs and business donations to food banks, but it also reinstates the expensing credits for corporations and multi national corporations, which are clearly not stimulative and will probably encourage higher executive salaries and bonuses.  Here is a partial list provided in an email from National Underwriters:
"Reductions in Individual Income Tax Rates
Extends the 10% bracket. Under current law, the 10% individual income tax bracket expires at the end of 2010. The legislation extends the 10% individual income tax bracket for an additional two years, through 2012.
Extends the 25%, 28%, 33%, and 35% brackets. Under current law, the 25%, 28%, 33%, and 35% individual income tax brackets expire at the end of 2010. Upon expiration, the rates become 28%, 31%, 36%, and 39.6% respectively. The legislation extends the 25%, 28%, 33%, and 35% individual income tax brackets for an additional two years, through 2012.
Individual Tax Relief
Above-the-line deduction for certain expenses of elementary and secondary school teachers. The legislation extends through 2011 the $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, supplies (other than non-athletic supplies for courses of instruction in health or physical education), computer equipment (including related software and service), other equipment, and supplementary materials used by the educator in the classroom.

Deduction of state and local general sales taxes. The bill extends through 2011 the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction permitted for state and local income taxes. Repeals the personal exemption phaseout for an additional two years, through 2012.
Repeals the itemized deduction limitation though 2012.
Capital Gains
Extends capital gains rates. Under the Act, through Dec. 31, 2012, long-term capital gains (with the exception of 28% rate gains and unrecaptured IRC Section 1250 gains) will continue to be taxed at a maximum rate of 15%; instead of 20% (18% for assets held more than five years).
Child Tax Credit
Extends the child tax credit. The legislation extends the current child tax credit for an additional two years, through 2012.
Marriage Penalty Relief
Extends marriage penalty relief. The legislation extends the marriage penalty relief for the standard deduction, the 15 percent bracket, and the earned income tax credit for an additional two years, through 2012.
Incentives for Families and Children
Extends the expanded dependent care credit, the increased adoption tax credit, the adoption assistance programs exclusion, and the credit for employer expenses for child care assistance.
Education Incentives
Extends the expanded Coverdell Accounts, the expanded exclusion for employer-provided educational assistance, the expanded student loan interest deduction, the exclusion from income of amounts received under certain scholarship programs, and the American Opportunity Tax Credit.
Alternative Minimum Tax (AMT)
Two-year AMT patch. Currently, a taxpayer receives an exemption of $33,750 (individuals) and $45,000 (married filing jointly) under the AMT. Current law also does not allow nonrefundable personal credits against the AMT. The legislation increases the exemption amounts for 2010 to $47,450 (individuals) and $72,450 (married filing jointly) and for 2011 to $48,450 (individuals) and $74,450 (married filing jointly). It also allows nonrefundable personal credits against the AMT. It is effective for taxable years beginning after December 31, 2009.
Estate and Gift Taxes
Estate, gift and generation skipping transfer tax relief. Prior legislation (EGTRRA) phased out the estate and generation-skipping transfer (GST) taxes so that they were repealed in 2010, lowered the gift tax rate to 35%, and increased the gift tax exemption to $1 million for 2010. Under EGTRRA, the estate tax was set to return in 2011, with the top estate and gift tax rate at 55%.

For 2010, the Act allows decedents dying in 2010 to choose between (1) the estate tax (based on a $5 million exemption and 35% top rate), or (2) no estate tax, but a carryover basis for income tax purposes, with $1.3 million and $3 million basis adjustments. Also for 2010, the gift tax exclusion remains $1 million with a 35% rate. For gifts made after Dec. 31, 2010, the Act reunifies the gift tax with the estate tax. The Act lowers estate and GST taxes for 2011 and 2012 by increasing the exemption amount to $5 million (indexed after 2011); and reducing the top rate from 55% to 35%. Further, a portability provision is added for 2011 and 2012 that permits a surviving spouse to apply any unused portion of a deceased spouse's $5 million exemption to the survivor's estate.
Payroll Taxes
Reduction in employee-paid payroll taxes. Under current law, employees pay a 6.2 percent Social Security tax on all wages earned up to $106,800 (in 2011) and self-employed individuals pay a 12.4 percent Social Security self-employment taxes of on all their self-employment income up to the same threshold. The bill provides a payroll/self-employment tax holiday during 2011 of two percentage points. This means employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to the threshold. Employer portion remains unchanged."
Needless to say, the political claims of which political party got what are diverse, but here is an independent analysis which shows President Obama got much less than he is claiming.  This tax cut compromise will not succeed in growing the economy and it is not designed to do so. There are four ways an economy can grow: personal consumption, investment, exports, and government spending.  With high unemployment there is little personal consumption growth and a little growth in demand which means investment is not forthcoming, because investment requires demand.  With troubles in Europe and inflationary and real estate bubble problems in China, which the Chinese government is trying to control with fiscal tightening, the possibility of exports is not promising.  This leaves government spending to stimulate economic growth in projects which provide jobs and in which the benefits far exceed the costs "... by taking advantage of the availability of low-cost labor and raw materials, rock bottom interest rates that make the cost of borrowing very low, and lots of infrastructure needs offering big benefits in transportation, environmental abatement, water and sewage systems, electrical grids, digital technology, and other areas."  A Federal pay freeze and continued political gridlock are not going to help and will continue to strangle growth in the economy. 

President Obama's political opposition are praising these tax cut policies, because they fully expect them to fail in such a way as to damage President Obama's chances for re-election.  This tax cut will create a slower growth rate pattern in the second year which almost always benefits the political opposition to an incumbent.  Unemployment should still remain high going into the 2012 election; this will also favor the opposition and is reason for them to hold unemployment as hostage as the extended benefits expire in 13 months and to use the two year expiration dates of the tax cuts and estate taxes to drive a wedge between the President and the real needs and interests of the American citizenry for jobs and access to economic opportunity.  That President Obama's economic and political advisers are either ignorant of or ignoring the extant literature documenting the effects of economic recovery on incumbent elections is inexcusable.

Even Moody's has recognized that the negative aspects outweigh the positive aspects of revenue in this new tax law and have warned they may lower the credit rating of the United States from Aaa as a result.

The Democrat and Republican parties have not served the best interests of the American people as a whole with this tax cut law choosing instead to jockey for political position rather than jump starting employment and sustained economic growth which benefits more than the top 2% wealthiest people.

Will "Yes, We Can" become a cry of political dissent and accusation from the economically disenfranchised and politically disenchanted rather than an affirmation of change?

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