Democrats and the Tax Cliff

By WSJ, Editorial

President Obama has staked his re-election on the promise to raise taxes on anyone making more than $200,000 a year, but it’s going to be fascinating to see if he can hold other Democrats through Election Day. June marked the third month in a row of lousy job creation, and the economy is growing slowly even as the January 2013 tax cliff grows closer by the day.

Already, as many as six Democratic Senators are hedging their bets as the economy looks worse. That list includes Joe Manchin of West Virginia, Jon Tester of Montana, Claire McCaskill of Missouri, Bill Nelson of Florida, Ben Nelson of Nebraska and Jim Webb of Virginia. The first four are running for re-election this year, while the last two are leaving the Senate. They haven’t all declared outright support for postponing the tax hikes, but they have expressed a willingness to negotiate a deal with Republicans that would avoid raising taxes on anyone next year.

Mr. Webb, for example, says he doesn’t want to raise income tax brackets on “ordinary income” but he favors raising capital-gains taxes. Senator Nelson from Nebraska told the Hill newspaper that “my druthers is to extend the tax cuts for everyone,” but he wouldn’t mind raising the tax on millionaires “if it has to come to that.” It doesn’t have to come to that if Democrats don’t want it to.

A spokesman for Senator McCaskill confirmed that she’s also willing “to compromise” on a temporary extension of the current tax rates. Florida’s Senator Nelson didn’t return our calls but has been reported in the press as open to an extension.

Messrs. Tester and Manchin both say that, rather than raising taxes in 2013, they favor an overhaul of the tax system along the lines of the Simpson-Bowles plan, which would lower tax rates while closing loopholes. That sounds close to the position of many Republicans—and akin to the offer that Pennsylvania Senator Pat Toomey made as part of last year’s Super Committee budget negotiations. Mr. Obama turned it down.

No doubt other Congressional Democrats from battleground states also feel jittery over the White House “Taxmageddon” strategy for 2013 but aren’t ready to publicly cross the White House. Last month Bill Clinton suggested a delay in raising the tax rates, before recanting amid a media uproar.

If Congress doesn’t act to change the law, tax rates on income, capital gains, dividends and estates are all scheduled to rise in January. (See the nearby table.) The best policy would make the Bush-era tax rates permanent pending a major tax reform. But at least a one- or two-year extension of the Bush rates would avoid a nasty hit in the near term to a still-vulnerable economy.

Business investment is slowing again, and the indices for manufacturing and services have been declining perilously close to contraction territory. The prospect of a nearly 60% increase in the capital gains tax and a tripling of the dividend tax only heightens investor worry and accelerates the flight into Treasurys or the financial sidelines.

That’s good for financing the government’s record deficits but bad for a private economy that needs a revival of animal spirits. Two weeks ago Congress’s Joint Committee on Taxation reported that 53% of the income tax increases that Mr. Obama would extract starting next year comes from business. Those are the businesses that aren’t hiring people as they wait out the tax and other policy uncertainties.

Meanwhile, Mr. Obama keeps attacking Republicans for refusing to pass his latest stimulus-spending splurge. He seems to have forgotten that less than two years ago the GOP won a landslide midterm election by promising voters they would end the avalanche of spending and debt.

The only jobs plan that has any chance of passing the House and Senate before the election is a bill to cancel all tax increases in 2013. With White House support, this would fly through the House and Senate and eliminate one major antigrowth headwind, as even some Keynesian economists and the Congressional Budget Office are telling the President.

The dilemma for the White House is that calling off next year’s tax increase would undercut Mr. Obama’s re-election theme of redistributing income. His liberal base has become so obsessed with the politics of envy that it is demanding higher taxes no matter the economic or political costs.

The question for Senate Democrats is whether they want to jeopardize their personal futures, and their majority, by jumping off the same tax cliff. With the House poised to pass an extension of the tax rates for at least one year, Senate Democrats have to decide if they want to vote before Election Day to wallop an already weak economy with a giant tax increase.

A version of this article appeared July 9, 2012, on page A14 in the U.S. edition of The Wall Street Journal

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