James Pethokoukis

Politics and policy from inside Washington

Bernanke right, Geithner wrong on Bush tax cuts

July 26, 2010

Ben Bernanke, the Federal Reserve chairman, doesn’t want tax rates to reset higher at the end of this year, even for the rich. The White House and the Treasury think differently. Here’s how an off-the-record Bernanke might try to talk Tim Geithner, the Treasury secretary, around to his point of view.

From:      Ben Bernanke <HelicopterBen@xxxxx.com>

To:          Tim Geithner <ObamaFan2008@xxxxxxx.com>

Subject:   Bush tax cuts

Date:       July 25, 2010

T-Dawg: First, major congrats on getting the financial reform bill passed. Trust me, I don’t want to have to make another late-night trip to Capitol Hill to beg Congress to bail out the banks. (Still worried about TBTF, though.) Man, can that Pelosi give a guy the evil eye! Hope the bill doesn’t cost you that future CEO gig at Goldman! (Totally joking!)

Second, those Bush-era tax cuts that are set to expire. Look, I told Congress  that extending them might help support the fragile economy, while you said they should expire, at least for the rich. And Congress seems on both sides of the issue — of course!

I know you guys are worried about the $1.5 trillion budget deficit. So am I. And I know the president campaigned against extending the tax cuts. But as I told Congress, the economic outlook was “unusually uncertain.” I’d prefer that the few monetary policy bullets I have left stay in the barrel.

So maybe you guys could help with fiscal policy. While letting all the Bush tax cuts expire would help lower the budget deficit by $341 billion over the next two years, it would also be the equivalent of about 3 percent of GDP in fiscal tightening over that period.

Letting rates rise on just the wealthy would be less contractionary, but could still bite. Here’s the thing: Your Treasury economists have found that capital gains taxes, mostly paid by the rich, have a big economic impact. Cutting them could generate enough growth to recoup 50 percent of the lost revenue. And I just ran across a Berkeley study hinting that the tax burden on higher earners may be at the point of diminishing returns. And if you look at history, cutting capital gains taxes is followed by more initial public offerings and more venture capital. That’s all good stuff.  Plus, letting income taxes on the “rich” expire would raise taxes on two-thirds of small business profits.  Just to be on the safe side, maybe we should leave rates alone for the next year or so.

As for the deficit, you probably saw that POTUS’s commission may agree to match every $3 in spending cuts with $1 in tax increases. Getting that sorted out correctly is more important than short-term tax revenue.

Anyhoo, I am wheezing on longer than my Humphrey-Hawkins testimony. Take care and say hi to Summers for me. (Hope he’s not still cranky about my second term!)

Cheers,

BB

Comments

Yawn. Why do rich need tax cuts? So they can buy stock/bonds/treasuries and sit on it? To incentivize becoming ultra-wealthy in the first place? So they can spend more on ultra-wealthy gadgets, villas and trips – often OUTSIDE of America? I haven’t really ever heard a compelling reason for tax-cuts for the rich… but I think I disagree on what the level of ‘rich’ is: $250k/yr for a working couple is not rich. I would argue the bar needs to be set at $1m/yr for a working couple, $400k/yr for singles. Times have changed and the levels of what constitutes ‘excessive’ wealth deserving of a higher tax rate need to change with it. Thoughts?

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