In Shutdown Fight, the Dog That Didn't Bark: Taxes

Posted: Oct 25, 2013 12:01 AM

Sherlock Holmes famously solved a mystery by noticing the dog that did not bark. In the recent government shutdown/debt ceiling fight, there was a five-letter dog that didn't bark: T-A-X-E-S.

Democrats insisted they wouldn't negotiate until they negotiated, and they insisted that a government shutdown was unprecedented although it was the 17th such shutdown since people started counting under the current budget rules in the late 1970s.

But if you read their lips, the two words that were never enunciated, even silently, were "new taxes."

This is something new. For more than 30 years, income tax rates have been a source of strenuous dispute between Democrats and Republicans.

Ronald Reagan, with the help of all congressional Republicans and a considerable number of Democrats, cut the high earner income tax rate from 70 percent (on "unearned" income) and 50 percent on wage and salary income first to 38.5 percent and, in the 1986 bipartisan tax reform, to 28 percent.

Congressional Democrats then proceeded to persuade George H. W. Bush to agree to an increase up to 31 percent in return for a promise to wall off defense spending. Bush hoped to prevent what he considered damaging defense cuts after the sudden end of the Cold War.

Democrats emerged from the 1992 election with the White House and majorities in both houses of Congress -- one of only two two-year periods of Democratic control since 1980. They promptly raised taxes on high earners to 39.6 percent.

It was a shrewd choice. Many people, including me, thought this would depress economic growth, and perhaps it did. But the economy grew smartly anyway.

In retrospect, the choice of a number beginning with a "3" rather than a "4" was shrewd. When high earners face tax rates approaching or exceeding half their income, they tend to channel their animal spirits into tax avoidance schemes rather than productive investments.

The talk at country club locker rooms in the 1970s took the form of "my tax shelter is bigger than your tax shelter." Economists tell me that they can't quantify the depressive economic effect of high rates, but the vibrant growth in the 1980s and 1990s, when top rates began with "2" or "3," suggests that it was not insignificant.

George W. Bush's 2003 tax cut, passed with some Democratic votes, lowered the top rate to 35 percent. Last January, Republicans reluctantly acquiesced in the fiscal cliff negotiations to a top rate increase to 39.6 percent. The alternative under existing law would have been a rate increase on all income taxpayers.

And there the tax rates stand. Democrats hoped that they could get Republicans to increase tax revenues in the spring in order to prevent the sequester's automatic defense spending.

But Republicans were willing to let the entire sequester go into operation, with the happy effect, from their point of view, of reducing domestic discretionary spending. They'd try to do something about defense later.

So early this summer, Senate Majority Leader Harry Reid was willing to agree with House Speaker John Boehner to let the sequester spending cuts continue with slight modifications, without demanding tax increases in return.

Boehner was not able to keep his end of the bargain, as enough House Republicans went into Cruz control and demanded the House pass bills at first defunding, and then delaying Obamacare. Reid was understandably angry that his concession on taxes was not reciprocated. He stood firm, anticipating correctly that Boehner would accept his original offer rather than refuse to lift the debt ceiling.

The dog that didn't bark remains silent. The Washington Post Wonkblog's Ezra Klein, sometimes a signal caller for Democrats, now recommends that "Democrats should abandon taxes."

And the plain fact is that the difference between the parties on taxes is relatively minor. Cutting high rates from 50 percent to 28 percent hugely changed incentives. Cutting them or raising them within the 35 and 39.6 percent range doesn't make nearly as much difference.

Limiting deductions for high earners -- something House Budget Chairman Paul Ryan would consider -- would mean more. But those deductions, as Klein notes, would hurt Democrats in high-tax states like New York and California.

Conventional wisdom has it that Republicans lost big on the shutdown showdown. But they kept the sequester and took taxes off the table -- pretty good accomplishments for a party that controls only one branch of Congress.

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