Should the Bush Tax Cuts Be Extended for America's Wealthy?

Democrats have generally supported President Obama's economic policies, but a divide may be opening between the White House and Democratic allies in Congress about whether to extend the Bush tax cuts for the wealthiest Americans.

"There's a growing chance -- above 50% -- that the Bush tax cuts will be extended for everyone," says Greg Valliere, chief political strategist for the Potomac Research Group, in a new report on the shifting political sands in Washington.

Get the Recovery on More Solid Ground

The latest defection was Sen. Kent Conrad, D-N.D., a fiscal conservative who has often spoken bluntly about the need to rein in the deficit, but who has now joined Republicans supporting an extension of the tax cuts for the wealthy. "The general rule of thumb would be you'd not want to do tax changes, tax increases ... until the recovery is on more solid ground," Conrad told reporters on Friday. He was joined by two other conservative Democrats.

Treasury Secretary Timothy Geithner appeared on the Sunday morning interview shows to appeal to Congress to extend the cuts for Americans earning less than $250,000, but allow them to phase out for the wealthiest 2% to 3% of taxpayers.

"We think that's the responsible thing to do," Geithner said, because the U.S. has got to demonstrate that it's starting "to make some progress bringing down our long-term deficits."

Tax Cuts Extended Without Offsets

But not all economists agree with the administration. Alan D. Viard, a resident scholar at the American Enterprise Institute, says he is disturbed by the political direction in which the tax cuts are extended for middle-class taxpayers without any offsets, meaning tax revenue increases or spending cuts elsewhere that would balance the continued loss of revenue.

"On the one hand we'll extend the middle-class tax cuts in full with no offset, but then we seem prepared to kill off the tax cuts at the top," Viard says. "It's just the opposite strategy of what you'd want. From an economic growth standpoint, it's the tax cuts at the top that have the most beneficial long-run impact."

Viard cited statistics from 2007 that show that taxpayers whose income was above $200,000 accounted for 80% of the capital gains and 40% of the interest income in the whole tax system. That shows that higher-income people save and invest more, fueling growth over the long run, Viard says.

The Rich Don't Live Paycheck to Paycheck

But Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities, says it's precisely for those reasons that Congress needs to maintain the cuts for the middle class but end them for the wealthy.

"Unlike middle class people, high-income people don't tend to live paycheck to paycheck," Marr says. "So their spending is much less sensitive to these changes in their income."

Marr says he would prefer to take the federal revenue from ending the tax cuts on the rich, which he estimates to be about $40 billion in the first year, and give that money to the states so they don't have to cut services and raise taxes. That would have the effect of stimulating the economy more, he says.

Most of the debate in Washington is focused on extending the tax cuts for only a year or two because of the ballooning federal deficit, which will hit $1 trillion this year.

Bernanke Favors Extending Some Cuts

Federal Reserve Chairman Ben S. Bernanke said that extending at least some of the tax cuts would help strengthen the economy. "In the short term, I would believe that we ought to maintain a reasonable degree of fiscal support, stimulus for the economy," Bernanke said. "There are many ways to do that. This is one way."

Bernanke carefully avoided saying whether he supported across-the-board extension of the tax cuts or only those for the middle class. His predecessor at the Federal Reserve, Alan Greenspan, has said the cuts shouldn't be extended because of the size of the deficit.

Donald Marron, the director of the Tax Policy Center in Washington, estimates that the effective tax rate would decline by 3.1 percentage points for the top 2% of taxpayers if the cuts are extended, while going down only by 1.98 percentage points for middle-income taxpayers. The poorest taxpayers would save about $70, middle-income taxpayer would keep about $970 and the wealthiest should save an average of $8,700.

Only the Rich Benefit

"The high-income folks on average don't spend as much [of their income], so in the short run, in the Keynesian world where you think about the next year or two, the tax cuts for them are less stimulative than for others," Marron says. "But that doesn't mean there is no stimulus effect."

He also points out that while the tax benefits aimed at the middle class would flow up to higher-income individuals, the high-income tax cuts benefit no one else.

Marron says that while it's often lost in the current political debate, the long-run question of how to tax work, savings and investment is the really important tax-policy issue for economic growth in the years ahead.

"If we could settle down on what we wanted our tax system to look like, it is certainly the case that finding a way to have lower tax rates would be more conducive to long-run growth," Marron says.