Fisher Investments Editorial Staff
Taxes, Politics

Politically Taxing Our Ears

By, 12/20/2010

Story Highlights:

  • President Obama signed the compromise tax rate extension bill into law Friday.
  • While many politicians supported the deal, some on both sides of the aisle are griping.
  • But their gripes and the overstatement of pluses from proponents are about politics, not economics.


President Obama signed into law the bill extending current tax rates for the next two years on Friday. We're in favor of lower taxes (or in this case, not having higher taxes) since allowing taxpayers to retain more of their earnings is an incremental economic boost. Plus, the resolution of this hotly debated issue removes some uncertainty from markets and the economy. Key elements of the new law include:

  • Marginal income tax rates, capital gains rates, and dividend rates will remain as-is for the next two years.
  • The employee-side payroll tax is reduced from 6.2% to 4.2% (employers will still pay 6.2%).
  • The alternative minimum tax gets another patch for 2010 and 2011.
  • The estate tax is reinstated following a hiatus but at the reduced rate of 35% with the first $5 million excluded. (The rate was 55% with the first $1 million excluded before 2010.)
  • Businesses will continue to receive a research spending tax credit and can now deduct 100% of investments in plants and equipment for 2011.
  • Long-term unemployment benefits are extended for 13 months, though this does not increase the 99-week limit. Rather, it extends the existence of 99-week unemployment benefits.
  • And sundry alternative fuel and energy subsidies.

Something for everybody—hooray! But not all lawmakers are jumping for joy. Some from each party have gripes.

Democratic opposition mostly focuses on tax rates for those with more than $250,000 in income (for married couples). They argue continuing current tax rates for "the rich" adds to a "wealth gap" subjugating the middle class. (Note: The definitions of "rich" and "middle class" are arbitrary—not everyone earning below $250,000 is middle class and vice versa.) This "wealth gap" supposedly stifles consumption and prevents middle-class income growth. But let's be clear: This argument is political, not economic.

While we're entirely for the idea of improving the quality of life for all Americans, the wealth gap is about relative incomes, not absolute. It's a comparison of average Joes' or Janes' incomes to modern-day Cornelius Vanderbilts (or just higher earners). We doubt many consumers make spending decisions this way—not buying goods because their income is lower than other earners. Moreover, in a very meaningful sense, the quality of goods consumed is far higher today (TVs, cars, computers, cell phones)—and more commonly owned. How does that indicate suppression of the middle class (once we can define what that actually means)? This theory has myriad faults, but the main flaw with the wealth gap theory is it rests on the assumption the global economy is a fixed size. Simply, it's not. (If it were, things like the now-ubiquitous smart phones couldn't possibly exist. Fixed pies don't allow for future profits from as-of-yet unimagined innovations.) So even if the top 1% or 5% are getting richer, that doesn't mean they must detract from lower income folks.

On the Republican side, most critics feel current tax rates should be permanent. Fine and dandy as political rhetoric, but there have been many US tax rate changes without an expiration date (theoretically, permanent). But they didn't last when tax winds shifted directions inside the Beltway.

Then there are some on both sides arguing the bill's costs are too high based on lofty estimates of lost tax revenue. These wild guesstimates (government forecasts are likely less accurate than weather forecasts—just review TARP estimates) utilize economic assumptions of the politicians themselves.  If the economy grows faster than forecast, tax revenues likely do too. That lowers estimated costs.

But rhetoric isn't limited to opponents. Assuming continued economic growth (likely), supportive politicians will likely claim the rate extension drove expansion and squelched an ugly alternative—conveniently overlooking five consecutive quarters of growth immediately preceding the bill's passage. (And that the previous recession occurred under the same tax rates!) While avoiding a big tax hike is an incremental boon to the US economy, claiming it solely drove a boom or prevented a bust is, at best, an overstatement.

The tax rate extension is a good thing, and we're pleased about it, but we'd also like more realistic economic discussion in Washington. But don't worry, we're not holding our breath.


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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