Crack Open the Eggnog? Compromise on Taxes In Sight

Per the New York Times, it appears the White House and Republican congressional leaders will soon conclude a deal to temporarily extend the Bush tax cuts for all income levels. The price: Republican acquiescence to another extension of federal unemployment insurance benefits.

Talk of compromise, tacitly endorsed by the President, emerged after Senate Republicans (joined by five Democrats) shot down Obama’s preferred tax bill over the weekend. It now appears that the tax cuts will be given another one to three years, kicking the tax policy can down the road but giving the incoming, more Republican-heavy Congress a better chance of a wrangling a permanent extension.

If the deal holds, its passage will be good news on several levels. As Anthony Randazzo noted on Friday, it means that taxes won’t be raised on some pass-through small businesses, leaving billions of dollars free to be invested in the economy. And as I pointed out in September, wealthy taxpayers have an important role to play in the recovering economy, both in driving consumption (though possibly at a lower rate than lower-income folks) and investment. Even Fed Chairman Ben Bernanke, whose approach to the crisis has often been criticized by fiscal conservatives, noted on “60 Minutes” last night that we should avoid raising taxes while the pace of growth remains sluggish.

Though I argued against extending unemployment benefits this summer on economic and budgetary grounds, prolonging them again is a small price to pay for preserving the Bush-era tax rates. The CBO estimated that the unemployment insurance would add about $56 million to the deficit over the next two years. By comparison, extending the life of the current tax rates over the same period would keep tens of billions in the hands of taxpayers* and flowing productively through the economy.

It’s important to note that this isn’t the end of the struggle over tax cuts – Congress will still have to deal with comprehensive tax reform as a part of any deal to tackle the federal deficit. And it’s an open question about whether this will be possible without tax increases.

* To respond to the argument that these tens of billions represent a cost to the gov’t and would “increase” the deficit:

– First, it’s unclear to me why an extension shouldn’t simply be considered a continuation of the revenue baseline that has existed for ten years. In other words, this isn’t a new “tax cut”, so why should we treat the revenue effects of it as if it were?

– Second, this ignores the salutatory effects of tax cuts on growth.

– Third, this ignores the unseen costs of a tax hike in the form of excess burden, the reduction in economic activity that takes place as people are incentivized to reduce their taxable income. The Tax Foundation estimated these costs to the economy at $65 billion in 2011 alone.