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December 9, 2010

Obama Tax Deal: Watch Your Language, Tax Cuts Don't Cost Government a Dime

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It’s the taxpayers’ money, not the government’s. That none-too-subtle distinction is at the heart of the language used to describe the proposed extension of the Bush-era tax rates.

And that distinction is important – from both an ideological and economic standpoint. When the money stays with taxpayers, especially through reductions in tax rates, the economy grows more rapidly. Workers and businesses face better incentives to work and produce, raising output and incomes – and ultimately tax revenues. In the end, the revenue loss from tax relief is significantly reduced by the revenue gained through a stronger economy.

That’s not to say that tax cuts pay for themselves. That’s rarely the case. But pro-growth tax cuts reduce revenues by a lot less than the typical “static,” or economically blind estimates typically driving debate in Washington suggest.

The alternative is for government to treat tax money as its property, claiming an ever-greater share, slowing economic growth, and thus actually cutting into tax receipts.

Taxes dont 'cost' government

Another aspect of this distinction relates to the word “cost” in the context of tax policy. Many commentators have misused the word “cost” in commenting on the grand tax compromise between President Obama and the congressional Republican leadership. Language can be very revealing. When the President or, say, The Washington Post talks about lower tax rates “costing” money, they reveal a fundamentally erroneous view: that government somehow has first claim on our money – that it somehow “belongs” to the government, rather than the person who earned it.

One alternative is to discuss the deal in terms of tax relief. The “grand compromise” includes some tax relief, such as the payroll tax holiday and a provision to let all businesses deduct their capital purchases immediately. This is tax relief because it provides relief from existing tax burdens. Such policy decisions relieve businesses from government imposed costs, but impose no “cost” on government because they do not require government to spend any money or other resources.

However, extending the 2001 and 2003 income tax rates is not tax relief, and it doesn’t “cost” government anything either. It provides no relief to taxpayers; it simply keeps the tax burden from rising for those who pay income taxes.

Your income belongs to you. You earned it – not President Obama, not Nancy Pelosi, not Harry Reid, not any of the politicians or talking heads so fond of arguing that those who refuse to let tax rates rise are “costing” government billions.

To extend current tax rates is simply to defer a massive tax hike – nothing more, nothing less. The grand compromise changes nothing as far as income taxes are concerned. It just means that every American earning income will go on paying at the same tax rates in place for the last 10 years.

Borrowing more or cutting spending

This simple fact has landed President Obama in a rhetorical quandary. He argues that the current law must be extended to keep those making less than $250,000 from getting hit with a huge tax hike. Yet he also characterizes the same action – extending the current law – as a huge tax cut for the rich. More than a curious inconsistency in language, such rhetoric is a real head scratcher for logicians as well as economists.

Which brings us back to the concept of cost. There is a cost to the tax deal. When government spends money, there’s a clear cost from economic and budgetary perspectives. But when government extends current tax policy, that’s not a cost. It’s not even tax relief, unless one believes that money earned belongs first to the government and is given to the taxpayer only through governmental generosity.

When government cuts taxes further, that, too, is not a cost to the government. It means government will either have to borrow more to keep the same level of spending or it will have to (gasp!) cut spending. But tax cuts don’t truly cost government one thin dime.

J.D. Foster is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at The Heritage Foundation.

First appeared in The Christian Science Monitor

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