Renew The Tax Cuts: Good Politics, Bad Economics?

Part of a series on tax policy

There's been a lot of teeth-gnashing in Washington and around the country this year over the big federal deficit. But it turns out there's a way the government could cut that deficit to a manageable size in just five years — by doing nothing.

"If Congress were to go home, not pass any new legislation, our tax policy alone, without any changes to projected spending, would get us to that sustainable level of deficit,” says Diane Lim Rogers, chief economist at the Concord Coalition, a deficit watchdog group.

The Deficit Picture

Here is the red ink that would result under three budget scenarios involving the 2001 and 2003 tax cuts. Raising taxes on families earning more than $250,000 — as President Obama has proposed — recovers only 15 percent of the overall revenue loss.

Deficit Projections

If Congress simply allows the tax cuts enacted by President George W. Bush in 2001 and 2003 to expire this year, as scheduled, tax rates would automatically revert to what they were in the Clinton administration. And the additional tax revenue alone would cut the river of red ink down to size.

For President Obama, though, there's a problem with letting everyone's tax rates climb back to where they were in the 1990s: He promised in the campaign he wouldn't do it.

"If you make less than a quarter-million dollars a year, then you will not see your income tax go up, your capital-gains tax go up, your payroll tax, not one dime," Obama famously pledged, while debating John McCain in the fall of 2008. Obama repeated that promise in his first address to a joint session of Congress.

"He's in the uncomfortable position of having made that campaign promise but yet also made a pledge to get the deficit down,” Rogers says. "I don't think he can keep both of those promises."

That's because the vast majority of Americans fall below that $250,000 threshold. Exempting 98 percent of the population from any tax increase might be good politics, but it really ties the government's hands when it comes to raising money.

Consider this: If everyone's tax cuts expire on schedule this year, the government stands to collect an extra $238 billion next year. Only about 15 percent of that would come from the very wealthy, those making more than $250,000. The rest — $202 billion — would come from everyone else. By letting everyone else off the hook for higher taxes, the president would add $202 billion to next year's federal deficit. And he can't blame that red ink on his predecessor, George Bush.

"As soon as President Obama signs the legislation, they will be the Obama tax cuts,” says Rogers, who also writes the blog EconomistMom.com. "When they have an opportunity to start with a clean slate, they're choosing to continue the policy that they blame for the terrible mess we're in."

Former Federal Reserve Chairman Alan Greenspan argues the government should let all of the tax cuts expire to keep from making the deficit worse. The president's former budget director, Peter Orszag, also called for an end to the tax cuts in a New York Times column on Tuesday, though he said the government should wait a couple of years until the job market is healthier.

The administration insists a bigger deficit is OK, arguing the tax cuts would stimulate the economy. Extending the cuts would save the typical family between $1,000 and $2,000.

"If you extend tax cuts for middle-class families, you're putting money in the pockets of people who will spend that money in places that are creating jobs,” says White House spokesman Bill Burton.

Maybe some jobs, but not many, considering the $202 billion price tag.

Average Tax Increase (In Dollars) By Quintile

Here, the average tax hike faced by taxpayers under two budget scenarios — if President Obama fulfills his campaign pledge to extend the tax cuts for only low- and middle-income taxpayers and if the tax cuts expire.

Quintile Obama's Plan Tax Cuts
Expire
Lowest 0 69
Second 0 583
Middle 0 1,016
Fourth 0 2,124
Top 2,916 9,018
Top 1 Percent 53,675 72,446
Top 0.1 Percent $310,140 $371,650

"Are there other ways to use that same amount of money that would give a bigger bang for the buck? The answer is definitely yes,” says William Gale, co-director of the Tax Policy Center in Washington.

He points to research by the nonpartisan Congressional Budget Office, which considered 11 different ways the government might stimulate the economy.

"Extending the Bush tax cuts came in No. 11 — the worst option, the lowest bang for the buck of any of the other options," Gale says.

If the government really wants to give the economy a boost, the CBO says, it would be better to spend the money building roads and bridges, cutting payroll taxes or providing aid to the states.

Gale points out the Bush-era tax cuts were never designed to be smelling salts for a faltering economy. When they were proposed a decade ago, the United States was booming and the federal government was running a surplus.

"If we're going to talk about permanent tax changes, let's have a discussion of overall tax reform and ways to make the system better,” Gale says. "Let's not just mechanically make permanent this thing that was passed in 2001 in a world that was very different than the one that exists now."

The Obama administration's fiscal commission is studying prospects for broader tax reform. But its recommendations aren't due until December. And by that time a decision on extending the tax cuts may have already been made.

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