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Obama’s diagnosis of America’s economic problem is right. His cure is all wrong

Author(s): James Pethokoukis

From the American Enterprise Institute:

President Obama finally found a tax cut Republicans don’t like.

In his State of the Union speech last night, Obama formally, if obliquely outlined his proposal for nearly $200 billion (over ten years) in middle-class tax relief. It includes an expansion of the existing child-care and earned income tax credits, as well as a new $500 “second earner” tax credit for married couples.

Now, it would hardly break Uncle Sam’s bank if Obama had chosen not to pay for these tax reductions. They would add just 2 percent to the projected level of debt accumulation over the next decade. That’s a rounding error. But Obama did decide to pay for them, by raising taxes on wealthier Americans. He wants to increase the long-term capital gains and dividend tax rates, eliminating a tax break for the “superrich” that allows inherited assets to escape investment taxes, and a tax on megabank borrowing. As Obama put it, “For far too long, lobbyists have rigged the tax code with loopholes that let some corporations pay nothing while others pay full freight. They’ve riddled it with giveaways the superrich don’t need, denying a break to middle class families who do.”

The GOP’s response has been one of talking-point uniformity, perhaps best encapsulated by a tweet from a spokesman for House Republican budget guru Paul Ryan:

That analysis is only half right. As political matter, the Obama blueprint is pretty distant from the sort of tax reform most center-right policymakers have been floating. It would add complexity and progressivity, and raise taxes overall. But the basic tradeoff of the Obama plan is perfectly reasonable. One way to raise middle-class incomes is to let folks keep more of their incomes away from the taxman. (An improvement, though, would be to expand the child tax credit to give more families higher take-home pay and more flexibility over their spending. Obama’s plan doesn’t help households with a stay-at-home parent.) And if you are going to pay the bill for lowering the middle-class tax burden, raising the burden for the rich seems logical during a time when the vast bulk of income gains appear to be going to the top.

But how Obama has chosen to mostly pay for his tax cuts is perfectly dreadful. Raising capital gains tax rates increases the tax code’s penalty on savings. Savings, when put to work as investment, boosts productivity and long-term economic growth. And you can’t substantially raise middle-class living standards in a slow-growth economy. Redistribution will only get you so far.

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