Extending the Bush Tax Cuts

By :: July 16th, 2010

What should Congress do about the Bush tax cuts that are set to expire at the end of the year? That question is going to absorb much of Washington’s attention through the fall and—if present hyper-partisan trends continue—perhaps even beyond. On Wednesday, the Senate Finance Committee kicked off the coming drama by bringing in a group of tax experts to set the stage.

The Tax Policy Center was represented by our current director, Donald Marron, and by one of our founders, Len Burman. Donald estimated the revenue effects of extending some or all of the 2001 and 2003 tax cuts, and described who would benefit from continuing these tax breaks. Len argued that while a permanent extension of all the tax cuts would be a fiscal catastrophe, Congress should temporarily continue those provisions aimed at low- and middle-income households who would most likely spend the money and boost the still-struggling economy.

As Donald noted, extending all the Bush tax cuts as well as continuing to exempt millions of middle-income taxpayers from the Alternative Minimum Tax would be very good news for high-income taxpayers and very bad news for the federal budget. Extending the individual income tax cuts and the AMT patch would reduce federal revenues by nearly $3 trillion over 10 years, relative to current law (which, of course, assumes all these tax breaks expire). The biggest beneficiaries of the individual income tax cuts, according to TPC estimates: the highest earning 20 percent of households, whose after-tax incomes would average 4.3 percent more than under current law. Those in the highest earning 0.1 percent (households making at least $2.7 million), would enjoy after-tax incomes that would average almost 7 percent, or about $370,000, more than if the Bush tax cuts expired.

Middle-income households would also reap some benefits of extending the tax cuts, but far less than the wealthy. Their after-tax incomes would average about 2.3 percent, or roughly $1,000, more than if the tax cuts disappeared.

Would extending the tax cuts stimulate the economy? Donald’s view is this step would boost short-run demand. But, he warned, that prediction comes with several caveats. When it comes to stimulus, all tax cuts are not created equal. Those targeted to low- and moderate-income households would produce more stimulus than those aimed at the rich, who would be less likely to spend the money. And, he added, much of the stimulus would not kick in until 2012, when families would get their 2011 tax refunds.

In the long run, the benefits of extending the tax cuts are less clear, especially if they are not offset with other tax hikes or spending cuts. This is important since, at the moment, neither President Obama nor very many members of Congress are interested in paying that bill.

Both Len and Donald agreed that rather than remaining focused on tax cuts, Congress ought to reframe the tax issue and begin to think about reform. There, I think both have it exactly right. Refighting the tax wars of a decade ago will inevitably make deficits worse and do little to boost growth. The best course may be for Congress to extend low- and middle-class provisions of the Bush tax cuts for a year or two, and use that time to design a serious tax reform.          

 

 

11Comments

  1. Anonymous  ::  5:17 pm on July 16th, 2010:

    Actually, when tax cuts are not made permanent, the withholding will change, so people will get less money each paycheck – which will hurt the recovery for lower wage households – especially if they adjusted their withholding for a larger child tax credit.
    I did not watch the whole hearing, but did see Sen. Grasssley's remarks on incentives, which I disagree with. When I was doing so, an answer to his view that higher taxes hurt small business came to me and I blogged about it. This is what I said:
    …Then it hit me, what motivates Senators?
    Campaign contributions – and in Grassley's case, seemingly contributions from people who want lower taxes. This makes it easy to devise an example that Grassley can understand.
    Let's suppose that in our example, Virginia did not have fixed conformity (meaning that what's taxable here is what's taxable federally). Instead, imagine that Maryland, the District of Columbia and Virginia all passed legislation making contributions to members of the Senate taxable at a rate of 30%. I say all three jurisdictions so that no one can simply cross the border to evade the tax with their grip and grin. Assume also that they considered contributions raised in the home state taxable income for Senators living part year in the national capital area – closing all loopholes.
    What would most Senators do? Would they decide that they don't need the extra money for their campaigns because it is being taxed? Buying Grassley's logic, you would think that would be the case. (Obviously he has not asked either his wife or my wife about the acceptability of working less when your income goes down.) The reverse is actually true. If the tax man taketh, the Senator will lean harder on more donors to make up the loss. So do small businessmen and households. The amount of money anyone wants is not a function of the tax rate they pay to get it, but rather on what ones wants to spend. If you raise the tax rate, people will work harder to make up the difference.
    This is why when Clinton raised taxes on the rich, the economy improved, revenue increased over and above the tax effect and the budget was balanced.
    Somebody needs to share this with Obama, so that he does not wimp out on letting tax rates for the wealthy expire when the ball drops on New Years Eve. Indeed, he would be dropping the ball if he buys Grassley's nonsense.

  2. Anonymous  ::  10:23 pm on July 18th, 2010:

    You start from a false premise. Your false premise is that it is better for any dollar to be in the hands of the government, than in the hands of any person (no matter how rich) or any business in the private sector.
    Since the government can only take wealth from the private sector and cannot actually produce that wealth, any dollar taken from the private sector and transfered (taxed) to the public sector will be used less optimally than if someone either spent it (which signals to the market what goods are valuable), or saved/invested it (which signals which investments are valuable).
    Therefore the role of taxation is to raise the minimum amount of money that government need to perform the essential task of government (income redistribution is not an essential task of government)in the least disruptive manner possible.
    Therefore it is clear that if we extend the Bush tax cuts and $3T remains in the private sector as opposed to being redirected to the public sector that this would be a net good to the economy and the country as a whole.

  3. Anonymous  ::  2:21 am on July 19th, 2010:

    Stop talking sense now. You might hurt somebody.

  4. Anonymous  ::  3:16 pm on July 19th, 2010:

    NO, your premises are demonstrably false. Intercontinental RR, organized by government and paid for by taxpayers, TVA, Interstate Highway system, DARPA, NIH… There are countless examples of government creating wealth.

  5. Anonymous  ::  4:29 pm on July 19th, 2010:

    So, spending on higher education produces no wealth? The interstate highway system is not wealth? I could go on.
    There is plenty of liquidity out there – however banks and wealthier families are sitting on it to the tune of trillions of dollars. Until that money is released into the private economy through either spending or investment (which takes place in response to spending – driving up stock prices is not to be confused with investment), the economy will stagnate.
    Income redistribution has actually been a legitimate function of American government since the passage of the Income Tax. The Republican Party could have, when they controlled all branches, investigated whether the 16th Amendment was really passed legitimately if there are any doubts, but chose not to. Only Congress has the plenary power to judge the ultimate passage of constitutional amendments, it is not judiciable. If they did not, don't blame the Democrats.
    Money being hoarded by the wealthy is not good for the economy. It must be shaken lose one way or the other – either by confiscation or by inflation (or both). It is hoped that econonomic sanity reigns, the same sanity exercised by Bill Clinton when he raised taxes on the wealthy by creating the 36% and 39.6% rates and got money moving again. It worked then and it will work now. If the President's economic advisors really understood economics, they would end the Bush cuts effective July 1st last, rather than waiting for them to expire.
    Republican obstructionism does no good in preserving these cuts – they go away automatically. The only question is whether the cuts for the middle class and the poor go away too (and ending these cuts would hurt the economy – since they would lessen spending). Reconciliation could be used to pass the needed tax cuts, the Dems just need the guts to do so.
    Finally, even absent redistribution, there is plenty of room for tax cuts – both to subsidize states (who are less able to raise their own tax rates) and to fund the war in Afhganistan.

  6. Anonymous  ::  2:58 pm on July 20th, 2010:

    I mean tax increases. There is plenty of room for tax increases just to fund those items that are non-redistributional in nature.
    I the long run, the children of the people who got the biggest cuts under Bush will eventually bear the brunt of repaying these cuts, since it is their future income stream which gaurantees the ability to maintain the debt.

  7. Anonymous  ::  3:10 pm on July 20th, 2010:

    One last point on redistribution – even aside the Income Tax amendment, the structure of the United States Government is rather flexible and what it does ultimately depends on what the voters want it to do. If the voters want redistribution, than redistribution is an essential task of at least the American government, libertarian objections to the contrary. This function does not derive from the delegated powers (although you can argue that it can be implied in the Commerce Clause and is explicit in the income tax), however it is clear from the structure found in the Constitution. Short of repealing the direct election of Congress, however, there is not much you can do about that. Any attempts to call such redistribution unconstitutional in the face of a structure that demands it are wishful thinking at best. It would seem that socialism (as defined by the Austrians) is an essential feature of our constitutional system.

  8. Anonymous  ::  6:13 am on July 23rd, 2010:

    Think about growth in wages and growth over the decade of tax cut after tax cut, with falling rate of employment, stagnant to falling wages, and a massive increase in malinvestment.
    The one thing to boost the economy was the increased government spending on infrastructure, building cities in Iraq for US military, transportation project funding (pork creates jobs), and rebuilding the Gulf after Katrina.
    As the tax cuts phased in and more tax cuts to create jobs were passed, the rate of employment fell from its peak in 2000, down the current rate which is at the level of the Reagan tax cut recession.
    The Reagan economy started creating jobs after Reagan agreed to sign tax hikes, one in late 1982 and three in 1983.
    The longest economic expansion and highest rate of employment came after the Bush 1990 and Clinton 1993 tax hikes. Those were predicted to cause stagnant growth and no job creation, and probably a recession.

  9. Anonymous  ::  8:27 pm on July 28th, 2010:

    There is one statement in this article that I particularly think is relevant and that is that a few thousand dollars more in a lower income income earner's pocket is more likely to be spent or “reinserted” into the economy than if that money (tax break) were to be bestowed on wealthier taxpayers. There are obviously several ways to argue this statement, but the main premise behind it is believing in a “trickle up” theory of economics versus a “trickle down” theory. I personally as a business owner believe in the “trickle down” thought process, but obviously to each his own. We are working on putting together a newsletter relating to recent tax law changes and how it will affect everyday taxpayers at http://www.federaldirecttax.com/ Please feel free to visit and subscribe to the newsletter for free monthly updates to the tax code and how its effect on tax payers and tax practitioners the like.

  10. Anonymous  ::  8:46 pm on July 28th, 2010:

    Trickle up is a rather odd way of describing rapid spending. The mechanics of why providing more funds to low income persons has a larger and quicker impact on GDP is straightforward. Lower income people spend each additional dollar more fully – they don't save – and more quickly – they spend it all in the following month rather than in the following 3 or 6 months. Thus, store shelves are restocked faster, and the supply chain of the economy is moving more product sooner for every dollar provided to a low income person. This has been substantiated in a series of papers by Parker and Broda about the efficacy of the Federal rebates.

  11. Norberto  ::  3:53 pm on July 23rd, 2013:

    Good article. I am going through many of these issues as well.
    .