To avoid the double-dip, (1) lower taxes, (2) raise taxes. Huh?

Nouriel Roubini & Michael Moran have a confusing policy prescription to avoid a double dip recession. First, they propose what is now a consensus idea, a payroll tax holiday. But then they argue that the income taxes on top earners should be increased. So, lower taxes AND raise taxes? What's distrurbing is that the essay falls back on cheap political reasoning:

Only a tiny percentage of Americans will end up paying more: the highest-income earners, who have already benefited greatly from the service the government (read: taxpayers) rendered to their brokerage firms and investment banks in 2008. Republicans may rail against increasing taxes on any American, but the complaints of the wealthy, in today's economic climate, will have little credibility among middle-class voters. In exchange for this increase, Obama can fashion a large tax break for employers and employees that jump-starts consumption, encourages hiring, and reduces the risk of a double dip -- all without busting the budget.

No, this is all wrong.

1. The "tiny percentage of Americans" includes a great deal of entrepreneurs. You don't even have to believe the higher incomes taxes will have a negative effect. They already are. Clearly, forecasters anticipated a summer of recovery that didn't happen. Pessimists, not just Republicans, decried the uncertain institutional climate. Here's how I spell uncertainty: There are fewer than 80 days before 2011 and nobody knows that income tax rates will be for successful entrepreneurs in 2011.

2. "already benefited greatly" -- yes, the rich did benefit. But didn't everyone else benefit from avoiding Armageddon, too?

3. "Republicans may rail" -- please, please, focus on the economics. It is silly to frame the tax climate issue as class warfare when there are substantive economic aspects that cannot be ducked. Tax raisers must justify why it makes sense to raise taxes on anyone during a fragile recovery. Peter Orszag said precisely this, and he's not exactly a GOP/rich hack.

4. "In exchange for this increase" -- who do they think Obama is going to be swapping horses with, Nancy Pelosi? Are these guys paying any attention to the upcoming House elections?

The economic logic for a payroll tax cut is sound. Rather than trying to reinflate aggregate demand (when most everyone believes AD was bubbly in 2004-2008), focus on expanding aggregate supply by cutting costs. Costs are easiest to cut on labor supply, namely the wedge of 800 billion dollars in payroll tax revenue. Roubini and Moran mention that, but also emphasize boosting consumption through the tax cut, and cloud the whole thing with an excess of bad political spin.

There is a rock solid playbook for a Democratic president 2011, and it was written by Bill Clinton in 1995. After the opposing party takes control of the legislature, a wise President goes centrist and can achieve real reform. It happened with welfare then, and it can happen with taxes and the budget next year. Here's what it should really look like: First, enact a pyaroll tax cut that is cyclically variant with the unemployment rate. That will make it better than budget neutral, it will make it part of the useful automatic stabilizers that are not politically dependent. Second, pick a fat entitlement program (Hint: Social Security) that needs reform and personalize it, i.e. every person gets the same amount - tied to the CPI - in voucher form. The unions might go crazy, but you can frame it as a budget friendly alternative to privatization, and you will outflank the right. You will have succeeded where your predecessor failed. Third, fight for a lower top marginal income tax rate.

Maybe that sounds crazy now, but increasingly, it's hard to find economic arguments that favor a progressive rate structure. If we are to have a science-based economic policy, Washington needs to acknowledge that the elasticity of taxable income is actually real, that is negative, and not a wingnut fantasy (see serious research by Martin Feldstein, Glenn Hubbard, Joel Slemrod ...). Incentives, it turns out, are important in tax policy. And you don't have to believe that America is on the wrong side of the Laffer curve, just that there is such a thing and that it actually does curve. Just consider this from an August 2010 summary paper by Slemrod, Saez, and Giertz:

While there are no truly convincing estimates of the long-run elasticity, the best available estimates range from 0.12 to 0.40. At the approximate midpoint of this rate -- an ETI of 0.25 -- the marginal excess burden per dollar of federal income tax revenue raised of 0.195 for an across-the-board proportional tax increase, and 0.339 for a tax increase focused on the top one percent of income earners.

That means a 1 percent increase in the tax rate on high-income earners leads to a 1/3 percent decrease in taxable income. And vice versa. (In all fairness, read the whole paper, because this actually is nuanced). My takeaway is that if American wants to increase wealth creation, simply lower the tax rate.

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