your federal government, both political parties, mismanaged the books and spent more money than they took in. our tax system is broken. half the country pays no income tax, and the rich pay as a percentage of their income less than the middle class does. we have a tax system that needs an entire overhaul and we've got a lot of interest to pay on the debt that we've accumulated. which is why, at least for the moment, you can't have a tax cut. but what president obama wants to do is extend a tax cut that you've actually been living with for about a decade. see, back during the final years of the clinton administration, the u.s. had a budget surplus. in the year 2000, the federal government took in $236 billion more than it spent. and the presidential election that year, then-texas governor george w. bush running against al gore pledged to give that money back to the taxpayers. >> we don't believe the surplus is the government's money. we know the surplus is the

people's money and we're going to send some of that money back to the people who pay their bills. >> and send it back he did. when he became president, through temporary tax cuts in 2001 and 2003 known as the bush tax cuts. the first of those tax cuts were set to expire back in 2010 but the economy was still shaky back then, so vice president biden and senator mitch mcconnell struck a deal to extend them for two more years for everyone. now those tax cuts are set to expire again at the end of this year. it is part of the so-called fiscal cliff that economists are warning the u.s. could go over if congress doesn't deal with it. now, president obama says let's extend them for another year -- but -- and this is the key point, not for everyone, just for what he calls the middle class -- families earning less than $250,000 per year, or individuals earning less than $200,000. >> i believe that we should make sure the taxes on the 98% of

americans don't go up and then we should let the tax cuts expire for folks like me, for the top 2% of america. >> now, you probably have heard that republicans want them extended for everyone, which means the battle comes down to whether 2% of taxpayers, the wealthiest among us, should stand in the way of everyone else continuing to pay the lower tax rate. this is a conundrum for some but not for fareed zakaria, and he proposes an unusual compromise between the right and the left that no one get a tax extension. fareed, i take it you don't plan to run for office any time soon. >> i do not plan to run for office. this is good policy, not good politics. >> why should nobody get a tax break at this point? >> well, because first of all, this -- if we were to say that all the bush tax cuts were to expire, it would be simply getting us back to the rates that everyone paid under bill clinton's eight years in office,

during which the united states had record and robust growth. secondly, we do have a deficit problem. we are spending more than we take in, and this is one very simple way to do it. if you let the bush tax cuts expire, the united states budget deficit goes down to basically the lowest in the industrialized world. you you no longer have a deficit problem. have you a long-term problem relating to medicare and health care costs, but all the things people are worried about disappear. and i think the argument that the economy is so weak that it can't withstand returning to these tax rates is probably not true anymore. the economy has slowly begun to recover. if you look at the housing market, it is clear that it has bottomed out. consumers have paid down debt. at some point we are going to have to get the fiscal house in order. this is the best mechanism. now i have a secret weapon here -- which is, i wouldn't -- that's my starting position. if you would come and say to me, okay, we don't want to put all these tax cuts in, let's delay

the -- let's phase this in over three or four years, i'd say fine, but why not instead then do a comprehensive tax reform. >> why not instead then do comprehensive tax reform? everybody from every party says it. we've seen the tax code. 73,000 pages. it is impossible for anyone to understand and it seems inherently unfair to almost everybody. why don't we do it? >> we don't do it because this is what congress doles out in return for campaign contributions. this is the institutionalized corruption at the heart of the american system. we don't do cash in brown paper bags and pass them under bridges the way that politicians in the third world do. we do it openly on k street. but what we are doing is essentially the same kind of corruption. what congress does is it raises money for its campaigns. a congressman gets $50,000. nobody is paying him $50,000 because they want to have coffee with him. he's not that interesting. what they're getting in return

is a specific line in the tax code, which is why our tax code is 73,000 pages. the french tax code, ali, is 1,000 pages long. german tax code is 500 pages long. ours is 73,000 pages long. what does that tell you you? we're giving away a lot of goodies in return for that cash. >> we may have the biggest tax code but you tend to point out that the american government, compared to other developed governments, is actually smaller. that is something i think people are going to find fascinating to hear. >> we have to keep in mind that when we think about america and we talk about tax rates and regulation, there are two ways you can compare, against some mythical past that we don't really know about or just against the other rich countries in the world. if you look at the united states against other rich countries in the world, we have a smaller government, we have lower taxes, we have lower regulations. so i'm all for more regulatory reform, more tax reform. these are all important things. but clearly that's not the big problem in america right now. the big problem in america, i would argue, right now is we

haven't gotte our fiscal house in order. we're spending all this money. to hear george bush talk about this is the people's money so we should give it back, fine, it is the people's money, but it is lts people's debt. we accumulated that debt doing things for people -- >> because people want things from government. >> people want things from government. they want medicare, they want medicaid, they want social security -- >> let's show our viewers a chart of projected impact of some of the biggest things in the economy right now. when you look at the top group, that orange section, the yellow section is the bush era tax cuts. then that middle group, the orange section is post-9/11, wars in iraq and afghanistan, the bottom is everything else. including medicaid. the bush tax cuts and wars are half our estimated debt. >> the important thing to notice here is that the bush era tax cuts and the wars, as you say, are about half of it.

and that was in effect a policy decision that was a set of -- a single set of policy decisions that could easily have not taken place. the blue, the other half, is an accumulation of lots of government programs that are, frankly, very popular. and the reason they have risen is not because those programs have gotten bigger. it is because more of us have aged so that the single most important reason that blue thing got bigger is medicare. more people have become -- have gotten older and since medicare covers them, more people again -- >> your point is that's not a single policy decision that we can take away. that's tougher. but the other stuff is actually easier. let me go back to another point you made. that is six months ago i could have agreed with your position that it shouldn't be extended for anyone, these tack cuts. i am worried that, given what is going on in europe and given the slowdowns in china and india, this is a couple billion people who were prospering at a greater rate and maybe able to buy some of our goods and services, that

we could be pushed into -- i've had some economists tell me a 30% chance of a recession. is this the right time to take that money away? >> so the ideal thing to do, in my opinion, would be not to try to stimulate the economy using tax cuts because the truth of the matter is people are not spending the money they are getting in the form of these tax cuts. we've tried it. remember, the single largest part of the stimulus program was a tax cut. before the stimulus, bush in his last months in office passed a tax cut. we've had two subsequent tax cuts. people aren't spending the money. they're paying down debt. they're marksed out. they're feeling poor. so these tax cuts are not getting back to the economy. the best thing we could do is restore the federal government's fiscal balance sheet and let the government spend money on infrastructure, on broadband, on science and technology. ali, right now this week, one of the most astonishing things happened. the federal government auctioned

off debt. basically we tried to borrow more money. what it turned out was the demand for american debt is overwhelming. if you adjust for inflation, here's what happened this week. people said to the american government, we will pay you money to hold our money. so can we lend you money? we don't want an interest rate. we will pay you a negative interest rate. we will pay you money. so the federal government is getting all this money. if it cannot find productive investments, we'd be crazy -- this would be the most mismanaged economy. it is actually fiscally irresponsible for us not to use this money to rebuild america. >> you have talked about rebuilding america through education and through infrastructure and other things. the criticism tends to be that the government can't seem to make the right decisions with regard to stimulus, it becomes a whole bunch of little projects of dubious return. will cain describes it as the christmas tree approach to decorating a stimulus. >> so here's the answer to that. the answer is something that a republican kay bailey hutchison

and president obama have jointly proposed which is an infrastructure bank. you take a certain amount of money from the federal government, you leverage it to get a lot more money from the private sector and you have an infrastructure bank that has a bunch of experts who determine what are the best infrastructure projects in this country. that means energy infrastructure, that means broadband, all these things. guess what? congress doesn't want to do it because congress doesn't want infrastructure projects awarded on merit. they want it awarded on cronyism, on the basis of political favors, on the basis of bringing back pork to their projects. so the problem here is, again, the best policy idea becomes politically unviable, but we should -- that is the right approach. we do need -- the great deficit in america is that we have the worst infrastructure in the advanced industrial world, broadband, energy, physical. we have to rebuild it. >> fareed, thank you for joining us.

up next, republicans clamt president's plan to let those bush tax cuts expire for the wealthy will hurt job creating small businesses. how many small businesses would really be affected? plus, romney's economic advisor explains how cutting tax rates can be done without costing you more money. and later, i've been saying that i'm going to name names of the problem solvers. but the first name i'm going to name is the person at the root of our political problems in this country. i have to know the weather patterns. i upgraded to the new sprint direct connect. so i can get three times the coverage. [ chirp ] [ manager 2 ] it's like working in a giant sandbox with all these huge toys. and with the fastest push-to-talk... i can keep track of them all. [ chirp ] [ chirp ] [ male announcer ] upgrade to the new "done." with access to the fastest push-to-talk and three times the coverage. now when you buy one kyocera duracore rugged phone, for $49.99, you'll get four free. visit a sprint store, or call 855-878-4biz. [ chirp ]

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president obama says let's extend the bush tax cuts for another year -- but this is the key point -- not for everyone, just for what he calls the middle class, families earning less than $250,000 per year, or individuals earning less than $200,000 per year. according to mitt romney, this is what he said -- successful small businesses will see their taxes go up dramatically and that will kill jobs." he said that on july 9th. now let's remember that democrats say the only reason that republicans want those tax cuts extended for everyone, including the top 2% of earners, is because they want to protect their wealthy donors. that, of course, is a tough charge to defend against, so republicans need a better reason to want the tax cuts extended for the rich, and calling it a job killing tax increase is arguably more effective. but just because romney and the rest of the gop make that claim doesn't make it true. christine romans, host of "your bottom line" joins me. christine, why does a debate

about personal income tax rates have anything to do with small business? >> oh, it does, ali. because the irs allows small businesses to report business income on their personal returns and those businesses can be structured in different ways. for example, limited liability companies. partnerships and s corporations. each has their advantages and disadvantages but you don't have to be a tax accountant to understand what this debate in washington is all about. all of these are called flow through entities, because the business profits flow through the company back to the owners. those folks then pay taxes on those profits at the individual rate -- millions of american business owners do this. >> how many of those millions of small businesses that use this flow-through would be affected by letting the bush tax cuts expire for top earners? >> very few. that's because most of them don't make enough money to be taxed at the very highest income levels. in fact, congress' joint

committee on taxation, a bipartisan group in congress, knows exactly how many small businesses would be affected. just 3.5% of all small business filers would find themselves there at the top of the income tax bracket. that's 940,000 people. that means the vast majority of small businesses in the country, more than 96%, would not see -- would not see higher taxes under the president's plan. >> so if mitt romney wanted to be more accurate, he could say something like, 3.5% of successful small businesses will see their taxes go up dramatically. so what is his claim that returning taxes to their 2001 levels for that 3.5% is going to kill jobs? what's that about? that may not be true, either because some of those so-called small businesses are often anything but small businesses. these are not mom and pops. these are not your corner dry cleaner or your eyeglass shop. we are talking in some cases about law partnerships, about hedge funds, about celebrities who incorporate themselves in

order to protect their assets against lawsuits or to write off expenses. many others who are simply people who work on their own. so many of the 3.5% of small businesses who would be affected are not job creating businesses in the first place. it's unclear that they would kill or create fewer jobs as a result of the tax cut expiring. in fact, in 2009, of the 400 richest taxpayers, 237 could be classified as small businesses because they reported income from one of those flow-through partnerships, or s corporations that christine was talking about. i want to bring in stephen moore, editorial writer for the "wall street journal." he enjoys telling me why i'm wrong each week and i suspect you're about to do it again. i'll give you a shot at me in just a moment but first i have a little more to say about whether small businesses are, as conservatives claim, going to get hurt by the failure to extend this tax cut to the rich. let us for a moment assume that

they are. that some percentage of the 940,000 businesses are in fact job creating, and that the expiration of their tax cuts will cause them to make less money. here's my proposed solution. it is not for everyone. i'm sure some accountants out there will disagree. say you are a business owner who files as an s or llc. why not switch over and become a standard c corporation. that way your business pays taxes at a lower corporate rate, you pay yourself a reasonable but not outrageous salary, keep it below $200,000, and you could lower your personal income tax that way. i just proposed a workable solution for a percentage of the 3.5% of all small businesses who may be affected by the expiration of the tax cuts and solved the job killing problem. tell me why i'm wrong. >> you just made my point. the taxes absolutely do affect behavior. what you described is exactly what will happen, because under obama's proposal, we'll actually have a higher tax rate on small

businesses than we do on big corporations which makes absolutely no sense. why would we tax small business with income of maybe $1 million at a higher rate than general electric? you're right, what will happen under what obama proposes is a lot of those companies will become corporations. i'm not so sure that's a good idea. here's my fundamental problem with what you and fareed were talking about earlier on the show. i just think, look, when you look at the income that is being targeted for these higher tax rates, you know this number -- i've heard you say it before -- 53% of that income is business income. right? it is not salaries. it is business income. a lot of that money gets re-invested in family-owned businesses, in manufacturing companies that maybe have $50 million or $100 million of assets but are not corporations. here's my problem -- look, you are right. small businesses, there are tens of millions of small businesses in this country. a lot of them don't make any money at all and a lot of them are just maybe one or two

employees. the major employers in this country do make more than $200,000, $250,000. they are the most likely to put out the help wanted signs. i just think it is very detrimental to raise taxes on them at a time when we have such high unemployment. >> i don't know that it is that detrimental but we just got this conversation started. we're taking a quick break. steven says if you are a small business enjoyer, enjoy the next few months because you are going to get hit with a tax bill you didn't see coming. we'll continue this battle when we come back. you're watching "your money." to being a different kind of communications company. ♪ we link people and fortune 500 companies nationwide and around the world. and we will continue to free you to do more and focus on what matters. ♪

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this is "your money." i'm about to bust a big myth -- that he letting the bush tax cut expire on the wealthy is a job killer. stephen moore is here to spar with us some more. you heard christine lay it out a few minutes ago -- only 3.5% of all small businesses, a number that's under 1 million small businesses, would see their taxes rise under the president's plan. many of them are not employers. isn't the gop -- forget the idea of whether you want taxes raised or not. isn't the gop being misleading with its definition of small business, because they are including doctors, they are including lawyers, they are including celebrities and hedge funds, people who do not create jobs with their bush tax cuts. is this not just a kenard, that it is about taxes? you know what business hiring is about -- it is about demand. if a company can make more money hiring people, than it will, regardless of its tax burden. >> look, i thought christine did a nice job of lafing out the situation with who pays what and how small business actually pay their personal income tax rates.

i thought that was very well done. i think what you guys are missing, listen, the top 1% or 2% we're talking about already pay half the income tax in this country. it is not as if they get away scot-free. they shoulder the big burden of the taxes already. a second point that i think is important to understand -- i bet there are a lot of businessmen and women watching this show right now, and i bet you what they will tell you -- i talk to them all the time -- if they make a half million profit on their company, they don't generally buy yachts or a ferrari. what they do is plow that money back into the company. right? this is what my dad did. he was a small businessman. ran a successful company. the more you tax those people, the less investment income they're going to get in their business and the less they'll put in that business, which means less investment and less hiring. i just don't see why -- look, i want the rich to pay more taxes, ali. i just think the way to do that is grow the economy. you don't grow the economy by raising tax rates while the rest of the world is lowering them.

>> you aren't going to drag me into an argument that i don't want to grow the economy. we both want the same thing. by not scaring our viewers off by giving them an accounting lesson, let's just discuss this for a second. one thing that would prompt business to spend more money, is that if you pay a higher amount of money to take that money out of the business than you would if you invest it in some fashion -- in machinery or employing people. wouldn't it stand to reason that it should cost you more if you want to create an intensive to create jobs to take that money out rather than hire more people? >> i got you on this one, ali! you're exactly right. we want people to re-invest money in businesses. i think we can both agree, the dumbest thing right now would be to raise the capital gains tax. what you are doing with the capital gains tax, capital gains is money that people invest in businesses and invest in stock when you increase the capital gains tax, you're reducing the incentive for people to invest in those businesses, and under the obama proposal on the taxes

on the rich, 60% increase in the capital gains tax, a tripling of the dividend tax, you can't be in favor of that if you want -- >> you'll have to come back next week to have that argument. right now we are talking about the bush era tax cuts -- >> i know, but that's part of it. but ali, that is part of the increase in the taxes, is the capital gains dividends and small business taxes all as one package. >> you perhaps unwisely admitted you were watching fareed and me have a discussion a little while earlier. you recall the time in which we created more jobs in the past is when our tax rates were substantially higher than they are now. this bush tax cut has been in place for ten years. i've heard you say this is not been the record ten years of job creation in america. why do we think under the higher taxes during the clinton administration we created more jobs than we are now under lower taxes? >> bill clinton did a lot of good things for the economy in a republican congress.

we cut the capital gains tax to 20% po 20%. we had free trade agreements. we had fiscal discipline. what i'm saying is we should have a world class tax system that lowers tax rates. let's get rid of all the deductions rich people take. that will force them to pay higher taxes. i think you put america at a competitive disadvantage if we raise our rates on businesses when people can invest in other countries where rates are lower. >> so tell me this then. if we just make this a fair conversation about whether or not you should raise rates on everybody or not on everybody, you are one of these guys who believes, not just in low taxes, but that the deficit is crushing. actually fareed agrees with you, too, he thinks that has an impact on consumer psychology. i'm not sure i am with either of you on this. but assuming it does, president barack obama's solution lowers the debt substantially more than yours. >> okay. let me give you one statistic on

this tax increase on the rich. even if you believe the most optimistic numbers -- which is that this is going to raise $70 billion a year -- by the way, i don't think this will raise any money at all because i think it is going to hurt the economy. even if you do that, here's the question for you and fareed -- where we going to get the other 93%? this only reduces the deficit by less than 6%! so it's not a solution -- anybody who thinks -- out there watching this show who thinks soak the rich is the way to reduce our deficit, it is just factually not true. you can't do it. >> all i set out to do was say that this business about small business, job killing stuff, is not accurate. i am kind of with you. what we have to -- >> you got to get some small businessmen on this show who will tell you -- >> i had several small businessmen on the show. i do agree the amount of money in the grand scheme of things between taxing the rich and not taxing the rich is actually quite small at this point. that i will concede to. >> you know why? because this is still a middle class country where most of the wealth in this country is still

in the hands of the middle class. >> we would like that to be the case. again, that's another discussion for another week. i'm not sure that is the direction we are going in but it is the direction we would like it to be. thank you so much. editorial riwriter with the "wa street journal." i have promised to name names. but it is not for doing the right thing and protecting america that's the storm that's approaching. it is for standing in the way. it is the name at the top of the list, the person most responsible for partisanship and polarization in america. stick around. i'm coming back and will tell you who it is.