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Why arguments for extending the Bush tax cuts are misguided

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William B. Plowman/NBC NewsWire/Handout/Reuters

(Read caption) Treasury Secretary Tim Geithner appears on "Meet the Press" in this photo released July 25. The U.S. economy is not likely to slip back into recession but letting tax cuts for the wealthiest Americans expire is necessary to show commitment to cutting budget deficits, Geithner said.

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It’s a big “rag on the Bush tax cuts” week in the Washington Post–I think because this is one of the biggest looming issues Congress and the Administration will be coming back to after August “recess.”

It began with Ruth Marcus’ column on Wednesday, where she wrote:

…Which takes us back to the matter of whether it would be risky to let any of the Bush tax cuts expire. As a practical matter, Democrats and Republicans agree that the cuts should remain in place, at least temporarily, for families making less than $250,000 a year. That’s a debatable point. Former Federal Reserve Board chairman Alan Greenspan, whose blessing was responsible for propelling the tax cuts forward in the first place, said recently that Congress should let them lapse.

The real disagreement is over extending the high-end tax cuts, and on this even some supposedly fiscally responsible Democrats — I’m talking to you, Kent Conrad — have gone wobbly. The no-new-taxes-now crowd cautions against raising taxes in a recession — a fair point, except that there are more efficient ways to spur the economy than giving more money to those least likely to spend it. Alternatively, they cite — and inflate — the supposed impact on small business of raising the upper-end rates.

This would be more convincing if the Republican line were something other than “no new taxes, ever.” The economic and fiscal circumstances may change, but the prescription remains the same. And the patient is too ill to tolerate another dose of this quack medicine.

And in the Sunday paper (already available online as of Friday), the Bush tax cuts are the focus of the “5 Myths” series as well as “Topic A.” Bill Gale of the Brookings Institution writes about “5 myths about the Bush tax cuts”. My favorite myths of the five are #1 (on the tax cuts as “stimulus”) and #5 (on the effect of the tax cuts on the longer-term fiscal outlook)–because Bill argues there’s not much to “love” in either case:

1. Extending the tax cuts would be a good way to stimulate the economy.

As a stimulus measure, a one- or two-year extension has one thing going for it — it would be a big intervention and would provide at least some boost to the economy. But a good stimulus policy can’t just be big; it should also offer a lot of bang for the buck. That is, each dollar of government spending or tax cuts should have the largest possible effect on the economy. According to the Congressional Budget Office and other authorities, extending all of the Bush tax cuts would have a small bang for the buck, the equivalent of a 10- to 40-cent increase in GDP for every dollar spent.

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Why? As the CBO notes, most Bush tax cut dollars go to higher-income households, and these top earners don’t spend as much of their income as lower earners. In fact, of 11 potential stimulus policies the CBO recently examined, an extension of all of the Bush tax cuts ties for lowest bang for the buck…The government could more effectively stimulate the economy by letting the high-income tax cuts expire and using the money for aid to the states, extensions of unemployment insurance benefits and tax credits favoring job creation…

5. Continuing the tax cuts won’t doom the long-term fiscal picture; entitlements are the real problem.

One theory holds that the country’s long-term budget shortfall is “just” an entitlements problem, the result of rising costs associated with growing Social Security rolls and increased health-care spending (via Medicare and Medicaid). Republicans like this idea because it plays down tax increases as a potential solution. Democrats like it because it makes the recent health-care package seem like even more of a triumph.

But it just isn’t true. The deficits we face over the next decade reflect a fundamental imbalance between spending and revenue, one that goes beyond entitlements. Based on projections by the CBO, Alan Auerbach of the University of California at Berkeley and myself, among others, even if the economy returns to full employment by 2014 and stays there for the rest of the decade, the continuation of current fiscal policies, including the Bush tax cuts, would lead to a national debt in the range of 90 percent of GDP by 2020. That’s already the highest rate since just after World War II — and Medicare, Medicaid and Social Security aren’t expected to hit their steepest spending increases until after 2020.

According to these same projections, the yearly deficit would rise to 6 to 7 percent of GDP by 2020. The Bush tax cuts would account for a significant chunk of this, considering that in each year they are in effect, the revenue lost because of them amounts to nearly 2 percent of GDP.

Compounding the problem: By increasing the government’s debt, the tax cuts have already led to higher interest payments on that debt. So even if all of the cuts expire on Dec. 31, we will still be paying for them for years to come.

And under this Sunday’s “Topic A,” it seems that no matter where fiscal policy economists fall on the ideological spectrum, it’s hard to find one who thinks permanent extension of all of the Bush tax cuts is a good idea. My response (just because this is my blog):

DIANE LIM ROGERS

Chief economist at the Concord Coalition and blogger at EconomistMom.com

President Obama will find it very difficult, if not impossible, to simultaneously keep two major policy promises: maintain the generously defined “middle class” portions of the Bush tax cuts and begin to restore fiscal sustainability by reducing the deficit to 3 percent of gross domestic product by 2015.

At the same time, current economic conditions suggest a continued need for deficit spending to assist in the recovery. Even if the Bush tax cuts are far from the most effective form of additional fiscal stimulus we could come up with, it may be all we can get right now, politically.

So one way Obama can avoid simply rubber-stamping the Bush tax cuts — and turning the policy he has labeled “fiscally irresponsible” into his own — while saving face on his promises would be to temporarily extend only those portions of the cuts he has proposed to permanently extend in his past two budgets. A one- or two-year extension would buy time for the economy to further recover, while providing policymakers with a realistic deadline to permanently reform the tax system to raise adequate revenue in a more efficient and equitable manner — in other words, to come up with a tax plan Obama would be proud to put his name on.

And in the informal survey of readers conducted on the page with Ruth’s column, as of Saturday 6 pm, 57 percent of respondents (out of nearly 1000) said we should let all the Bush tax cuts expire as scheduled. (Snapshot above.)

UPDATE (Saturday night): Stephen Colbert’s take on the issue. (Thanks to Len Burman for calling this to my attention via Facebook.)

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