- With interest rates this low, a tax hike isn’t really necessary to pay for the infrastructure.
- Democrats see an infrastructure bill as an opportunity to reshape tax legislation.
- You can try However, an even better opportunity will arise in 2025.
- This is a split opinion. The thoughts expressed are those of the author.
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As negotiations in Congress on a large infrastructure investment package continue, one point emerging among Democratic moderates like Joe Manchin and their more liberal colleagues is that the package should include tax increases to “pay for” some of the spending.
I doubt the merits of this idea. Interest rates are very low, despite the fact that $ trillion in additional government bonds have been raised in recent years. This is an unusually good time, therefore, to finance government spending with loans – especially when that spending is on useful infrastructure projects that support economic and economic growth – the tax base.
And if the infrastructure projects don’t grow the economy because they are wasteful – and I agree with Matt Yglesias that, given the unreasonable prices we pay for new infrastructure in the US, waste could be an integral part of any infrastructure push – they should do not do this not be built at all. Tax financing instead of debt financing wouldn’t make these projects a good idea.
So I don’t think you need tax increases to “pay” the infrastructure.
But there could be another reason to raise taxes. Sooner or later interest rates will rise and the budget deficit will have to represent a smaller percentage of GDP. The 2017 tax cuts were irresponsibly high and resulted in tax revenues likely to be too low to fund ongoing government operations in the long term.
Now that the Democrats are in charge of government, they have the opportunity to shape the future of federal fiscal policy – by changing tax laws so that any budget adjustment is more based on tax increases for the rich and less on spending cuts or tax increases for the middle class. A tax hike now also creates more room for the introduction of new government services before that tax ceiling is reached – expenditures that serve a useful purpose but that, unlike infrastructure, cannot be expected to be financed by economic growth.
But I still think the Democrats could start this project a few years early.
The 2017 tax bill was a win for Republicans, but it also creates opportunities for Democrats in 2025
Immediately after the GOP Tax Cuts and Employment Act (TCJA) was passed in 2017, I wrote about how it provided an implicit blueprint for Democrats to reshape tax legislation to their liking in the future.
- The main permanent provisions of the tax cuts relate to corporate income tax, which has more bipartisan agreements than individual income taxes. Proposals for democratic corporate tax reforms, such as those proposed by the Obama administration, contained some similarities with the Republican approach, including lowering tax rates in exchange for a broader tax base. Biden has proposed raising the corporate tax rate from 21% to 28% – not up to the pre-2017 level of 35%.
- The tax changes to the law for natural persons will largely expire at the end of 2025. These include tax cuts for middle- and high-income households, the expansion of the child tax credit, a large increase in the standard deduction, and the elimination or reduction of various individual deductions. My least preferred provision in the 2017 Act is a small business income tax preference designed so that entrepreneurs pay lower tax rates than business employees. This will also expire after 2025.
- A significant individual income tax increase in a package – the use of a lower inflation measure to index the tax brackets – is not going to expire. This is a stealth tax increase for both middle and high earners, and creates a base so that you can have more individual income tax revenue in the long run than if there had been no tax if you cut all expiring individual income tax laws at all.
When you combine these three facts, you will have an opportunity for Democrats to use the flow of parts of the TCJA to reshape tax law. If they control the presidency or one of the convention houses, they can agree to extend just some of the provisions – presumably focusing on child loans and cuts for middle-income taxpayers – while also phasing out other tax breaks. You can also trade horses through corporate tax and seek a moderate increase in the tax rate to offset the cost of extending certain tax breaks.
However, this leverage will not materialize until 2025, when most of the TCJA regulations expire.
So Democrats have two options on the table. You can now enforce tax increases by relying on their very close majority in both houses of Congress, with the great challenge of reaching a party-wide agreement on how taxes should be collected. Members will then have to seek re-election to justify the tax hike – which, Republicans will note, affects not just high earners, but the (much more popular) small businesses they own.
While in 2025 Republicans will be forced to negotiate a bipartisan deal on the future of tax policy if the Democrats in Washington have some power, or much of the TCJA will simply expire.
These options are not mutually exclusive. Democrats can request some tax changes now by using their majority, and later by using the scheduled expiration times. However, the availability of the “later” option reduces the urgency to make some of the changes now, particularly those related to small business, which would be more politically challenging.
Democrats used this two-bite-on-apple approach in the Obama administration
In 2001 Republicans passed substantial income tax cuts, most of which were only meant to last for 10 years. The intent was for these tax cuts to be effectively permanent – that they would be extended later – but budgetary rules forced the use of an initial 10-year window. After the big one
recession
There have been temporary extensions of almost all provisions.
However, after the 2012 election, the Democrats refused to allow any further expansion of the very high earner regime. Faced with the threat of complete wiping out of the Bush tax cuts, Republicans agreed to an agreement that made middle-income tax cuts permanent, while the top income tax rate rose from 35% to 39.6% before 2001. Capital gains Tax rates for high earners also fell from 15% to the old level of 20%.
Prior to this deal, the Democrats had already passed the Affordable Care Act to significantly increase income tax without a Republican vote. This law resulted in tax increases on salaries and capital gains for high earners, which remain in effect to this day. The combined effect of all of these tax laws is that, after all the changes in the Bush and Obama administrations, federal individual income tax was much more progressive than it was when it began.
This story provides a model for Biden as he tries to set the long-term course for US tax policy: Take a politically acceptable tax hike now as part of an infrastructure package and then look for another one as part of the TCJA process in 2025.
And of course he should try to hold the presidency until then. Just as the re-election of Barack Obama in 2012 sealed the fate of Bush’s tax cuts, Democrats will need to retain some power after the 2024 elections to take advantage of the leverage provided by these decay times. Elections have consequences, so it’s important to win them as always.