What is Barack Obama's Long Term Game on Taxes?

Posted: Oct 12, 2011 12:01 AM

Considered in isolation, payroll tax cuts in the jobs bill look like a crass political stunt: reducing revenues by $240 billion next year and then magically disappearing right after the November elections.

But in off the record conversations, Democratic strategists insist that these “temporary” tax cuts actually represent one step in a multi-stage plan for permanent transformation of the tax system, achieving a sweeping redistribution of money and power. If the President executes this scheme as anticipated, Republicans – even with their disciplined majority in the House – may find it difficult to stop him.

Mr. Obama urgently demands that Congress slash tax burdens for some 40% of Americans (who pay nothing in federal income taxes) by approximately one-half: dropping the Social Security tax rate from last year’s 6.2% to 3.1% next year. A typical family earning $50,000 would surely welcome the chance to keep $1,500 more of their own money, but how would they feel if Washington erased that break in 2013?

Veteran observers know that proposed changes will prove no more fleeting than the last payroll cut — to 4.2% from 6.2%--that the lameduck Congress cheerfully enacted in December, 2010. As the president noted in his joint session speech: “If we allow that tax cut to expire-- if we refuse to act-- middle-class families will get hit with a tax increase at the worst possible time…I know some of you have sworn oaths to never raise any taxes on anyone for as long as you live. Now is not the time to carve out an exception and raise middle class taxes . . .” And when, exactly, is the time for a working politician “to carve out an exception and raise middle class taxes”?

In other words, the new low rates in payroll taxes for every American household won’t suddenly evaporate at the end of 2012; they will become permanent, shrinking revenues not by $240 billion in a single year, but by at least $2.4 trillion over 10 years.

Revenue reduction on this scale would swamp any combination of spending cuts and tax hikes cooked up by the Congressional Super Committee in November… more than doubling the 1.5 trillion in 10 year deficit reduction they need to find. What could government possibly do to plug the resulting hole in its budget?

The answer is easy, organic, inevitable: the sneaky element of Obama’s purported plan. If official Washington does what comes naturally – doing nothing – more than enough money will automatically cascade into the federal treasury to cover the president’s schemes, starting on January 1st, 2013 (once he is safely re-elected).

Congress and the White House may reach agreement on lowering payroll taxes, but they will likely remain deadlocked on further extension of Bush cuts in income tax rates – cuts that automatically disappear at the end of 2012. No, not the Bush tax cuts for the “millionaires and billionaires” the president loves to deride, but the Bush tax cuts for everybody.

According to CBO projections, if all Bush tax reforms lapse in 2013 revenue will soar by $4 trillion over the next 10 years (compared to the relatively modest $700 billion increase if, as Obama publicly demands, only those earning more than $200,000 saw old rates return). For those who gripe about every tax-paying household sending bigger income tax checks to Washington, the president can blame Republicans: after all, he wanted to extend the tax cuts for everybody except top earners but the GOP (just as in 2010) will refuse to take that deal.

If this plan unfolds as the administration hopes, within 15 months President Obama will have achieved a fateful, historic shift of the federal tax burden from the highly regressive payroll tax to the sharply progressive income tax. The portion of federal revenue generated from Social Security payroll taxes (with their flat rate and cap of $106,800 in taxable income) will fall by nearly half while increases in the income tax burdens for everyone (with a new top rate of 39.6% and higher rates across the board) will more than cover all losses.

David Leonhard of the New York Times, one of President Obama’s favorite economists, has been arguing for months that the best way to solve the budget mess is for Congress and the president to remain deadlocked on extension of the Bush tax cuts, and to see income tax rates go up automatically across the board.

The overall result would mean those earning less than $50,000 (and paying more in payroll taxes than income taxes, if they pay income tax at all) would see major reductions in their tax payments. But those earning $100,000 or more would see burdens sharply increased-- with limited benefit from payroll tax cuts (which apply only to the first $106,800 we earn) but major increases in income tax on every dollar.

Remember, the return to across-the-board Clinton rates wouldn’t just hit those earning more than $200,000. Income currently taxed at 10% would go up to 15%, money taxed at 25% would rise to 28%, and so forth.

Success in this tax strategy could fundamentally change the nature of government. Nearly half our citizens already get more from Washington in benefits of various kinds than they pay in taxes. With even lower contributions in payroll tax from the 42% who currently pay no income taxes at all, those figures will soar. Government would cease to demand that every citizen provide some level of support for necessary operations and would become instead a mechanism for transferring wealth from the more successful (who will pay vastly more taxes) to the less successful (who will receive undiminished benefits, while paying even less into the system than they do today).

Mr. Obama’s payroll tax holiday isn’t an emergency measure that may or may not create jobs. It’s part of a major reconfiguration of the tax system in a sharply more progressive direction. The GOP must respond immediately with their own restructuring plan, including sweeping reform and radical simplification. They should build on the president’s own Simpson-Bowles deficit commission, demanding lower rates for all combined with elimination of loopholes and broadening the base. This approach provides great advantages in transparency and rationality--while insuring that everyone (including earners at both ends of the income scale) pays a fair share.

If the GOP fails to see the current skirmish as part of a decisive, long-term battle they will lose--facing defeat in both political and policy terms. The president has staked out a likely course of action that delivers the sort of “big change” he has always extolled. If the Republicans hope to respond effectively, they can do no less.

Editor's Note: A version of this column originally ran in The Daily Beast.

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