A Deal Worth Making

Count me as a supporter of the recent deal between the Obama administration and Congressional Republicans to prevent the Bush tax cuts from expiring on January 1 and to resolve absurd state of estate tax law.

The compromise is just that: it reflects many elements which are disturbing. Most importantly, the tax cuts and estate tax are resolved only for the next two years, whereas the positive impact on economic growth from the Bush tax rates would be much more significant if the tax law was permanent.

To reignite economic growth and reduce unemployment, we need individuals, businesses, and investors to take risks on new investment opportunities, and the aftertax rate of return on those investments is the fundamental determinant of whether, and how much, new investment occurs. And since new investments have a return typically measured over many years (often decades), lowering taxes (or more accurately, not allowing tax rates to rise) permanently would raise aftertax returns much more significantly than a two year tax plan with the tax rates scheduled to rise afterward.

But allowing tax rates to rise would be much worse, so two years of lower taxes with the ability to refight the battle later is better than nothing.

The estate tax change is genuinely a good thing, since estate tax law has been subject to the absurdities that John McCain and others inflicted on the nation when the Bush tax cuts were first passed. Estates were not taxed at all in 2010, but death tax rates were scheduled to increase dramatically on January 1. The compromise raises the level at which estates gets taxed, and reduces the tax rate, while preserving the estate tax. I'd much prefer to see estate taxes abolished, since after a lifetime of paying taxes on one's money, it is obscene to take 55% of one's money at death (the pre-Bush tax cut rate that would have taken effect on January 1 without the new law). But a 35% tax rate on estates over $5 million is more equitable than a 55% tax rate on estates over $1 million that would have occurred on January 1.

What is most disturbing in the law are the provisions that pay off various Senators for their support, such as maintaining the ethanol subsidy. It is also disappointing that spending wasn't cut to offset the cost of various provisions to reduce their impact on the budget deficit.

But this is the political reality of divided government: Republicans can't get all they want, nor can Democrats.

It is interesting that a number of aspiring Republican presidential candidates, such as Mitt Romney and Sarah Palin, oppose the deal. While that may or may not be good politics, it is bad economics.

Meanwhile, the Democrat left who oppose the deal, vociferous in their denunciations of the bill and Obama for agreeing to it, demonstrate their belief that the earnings of Americans belong to the government and that a tax cut (or preventing taxes from rising) is "giving" money to the affluent.

Quite the opposite: lower taxes mean people keep more of their own money, while higher taxes means the government confiscates more of your money.