President Barack Obama

Barack Obama made a big deal throughout the campaign and after that he wanted to raise income taxes on the rich by reversing the reductions in upper rates enacted under President Bush in 2001. Lower rate advocates have argued all along that lower rates are better for the economy, whereas raising the individual income tax rates again from 35 percent (which is already too high) to 39.6 percent or higher would hurt the economy. By proposing higher tax rates, Obama and his allies explicitly discounted the economic effects. Rumors in Washington suggest the President, facing persistently high unemployment, may have been mugged by reality in the immortal words of Irving Kristol. Obama may have come around to a more conservative position in favor of lower rates, at least for now.

Last year my colleague, Bill Beach, and I argued for a pro-growth alternative to ineffective, debt-laden fiscal stimulus. Senator Jim DeMint (R-SC) led the fight in the Congress for stimulus that would work, but congressional leadership and Obama chose instead to pass a $787 billion debt hike masquerading as stimulus. The centerpiece of any effective pro-growth proposal was obviously to delay for some number of years the increase in tax rates that would otherwise occur with the expiration of the 2001 tax relief.

The best solution, of course, is to make the tax rate relief permanent, but that’s a debate better left to another day years from now. The immediate task is to delay the rate hikes. If the rumors of the President’s epiphany are true and he is willing to delay the rate hikes, that would be real progress.

The broad consensus appears to be that if the economy can avoid any more disastrous shocks, then the unemployment rate ending 2010 is likely to be about where it is today, at 10 percent. Obama should demand a delay in raising tax rates until the economy is materially stronger, say until the unemployment rate dips below 6 or 7 percent. If he were to do so, following the advice we gave at the start of 2009, it would provide the economy with a needed boost on at least three counts:

  1. It eliminates a threat to the economy from Washington as highlighted in a recent Chamber of Commerce report;
  2. It would delay the vitality draining effects of higher rates on capital formation and entrepreneurship in America; and
  3. It would suggest the President finally is starting to “get it”, that higher tax rates are bad for the economy as we’ve said all along.