Keep the Bush Tax Cuts for a Couple of Years, But Reshuffle the Dollars

It seems increasingly likely that Congress will extend most, if not all, of the Bush tax cuts for at least a year or two. As the economy shows growing signs of softening, lawmakers are less and less likely to take steps that will be seen as “raising taxes.” But there is a way Congress could maintain the magnitude of the Bush tax cuts while moving around some dollars to enhance their short-term economic benefit. The goal of this shift would be to focus tax cuts on those most likely to spend the money.

Here’s the problem: The Treasury Department figures that temporarily extending the 2001 and 2003 tax cuts would reduce federal revenues by roughly $200 billion in Fiscal 2011 and $260 billion in 2012. For technical reasons, those numbers may be off a bit, but you get the drift. Of that, about $75 billion would go to top-bracket taxpayers ($35 billion in 2011 and $40 billion in 2012). We know that higher income households are more likely to bank the cash than spend it. As a result, tax cuts for these high-earners will do relatively little to boost the economy in the short run.

So why not take that $75 billion and give it to those who are more likely to spend it—people with low- and moderate incomes. It would be simple to do. Congress could, for example, expand the Earned Income Credit. Or it could continue a scaled-back version of President Obama’s Making Work Pay (MWP) tax credit that is also due to expire at the end of the year.

My colleague Elaine Maag wrote recently about the benefits of extending a modified version of the MWP credit. But Elaine got me thinking: Instead of continuing the credit in addition to the Bush tax cuts, why not use it to replace some of the least stimulative provisions of the 2001 and 2003 tax laws. Btw, Making Work Pay also benefits some small businesses, including many self-employed people: Keep in mind the average amount of business income reported on individual tax returns is only about $40,000, far below the MWP threshhold.  
 
Extending Making Work Pay would cost about $60 billion-a-year. But by trimming it, and focusing its benefits on low- and moderate income households, Congress could fit these tax cuts into a two-year $75 billion bucket and still provide a modest boost to the economy.

There is a potential political benefit to moving these dollars around as well. Republicans could say they extended all of the Bush tax cuts (at least in magnitude, if not in specifics). And Democrats could take credit for retargeting those upper-bracket dollars.  

Economists generally agree that Washington is in a serious fiscal jam. It needs to boost an economy that may again be running out of steam. But given long-term deficit challenges, it also must conserve precious federal dollars. In this environment, it is imperative that policymakers get the biggest bang for the every stimulus buck.

So instead of squabbling over whether or not to continue $75 billion in tax cuts, Congress should simply retarget the dollars to those most likely to spend them.