Recall the 2001 and 2003 tax cuts were written to expire, for the most part, in FY2011. I wrote in February that one way to start fixing the Nation’s finances is to let the EGTRRA and JGTRRA expire as they were originally designed to. Via EconomistMom comes Bill Gale’s additional reasons why we should, despite the lackluster recovery  (more on that below).
The Myths and Gale’s Rejoinders
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.
2. Allowing the high-income tax cuts to expire would hurt small businesses.
This claim is misleading. If, as proposed, the Bush tax cuts are allowed to expire for the highest earners, the vast majority of small businesses will be unaffected. Less than 2 percent of tax returns reporting small-business income are filed by taxpayers in the top two income brackets — individuals earning more than about $170,000 a year and families earning more than about $210,000 a year.
3. Making the tax cuts permanent will lead to long-term growth.
A main selling point for the cuts was that, by offering lower marginal tax rates on wages, dividends and capital gains, they would encourage investment and therefore boost economic growth. But when it comes to fostering growth, this isn’t the whole story. The tax cuts also raised government debt — and higher government debt leads to higher interest rates. If estimates of this relationship — by former Bush Council of Economic Advisers chair Glenn Hubbard and Federal Reserve economist Eric Engen, and byoutgoing Office of Management and Budget Director Peter Orszag and myself — are accurate, then the tax cuts have raised the cost of making new investments. As the economy recovers and private borrowing rises, the upward pressure on interest rates is likely to grow even stronger.
I have used standard growth and investment formulas to calculate that the overall effect of the Bush tax cuts on economic growth has therefore been negative — and it will continue to be negative if the cuts are extended.
4. The Bush tax cuts are the main cause of the budget deficit.
Although the cuts were large and drove revenue down sharply, they are not the main cause of the sizable deficit that exists today. In 2007, well after the tax cuts took effect, the budget deficit stood at 1.2 percent of GDP. By 2009, it had increased to 9.9 percent of the economy. The Bush tax cuts didn’t change between 2007 and 2009, so clearly something else is to blame.
The main culprit was the recession — and the responses it inspired. As the economy shrank, tax revenue plummeted. The cost of the bank bailouts and stimulus packages further added to the deficit. In fact, an analysis by the Center on Budget and Policy Priorities indicates that the Bush tax cuts account for only about 25 percent of the deficit this year.
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.
Read the entire article here.
The Budgetary Impact of Extending EGTRRA and JGTRRA vs. Extending Unemployment Insurance, or Maintaining Food Stamp Payments
A couple of observations. First, letting these tax provisions expire would have a lot more impact on the budget deficit than denying the unemployed an extension of their unemployment insurance, or cutting food stamp payments (after all, the Republicans have not demanded an offset to be found for the EGTRRA/JGTRRA extensions, as they have for the proposals the Administration proposed in the jobs bill). 
Second, EGTRRA/JGTRRA will be more “budget-busting” as we go forward. Just to remind readers, here’s a decomposition of the budget deficits going forward, depicted in this Figure from the Center for Budget and Policy Priorities’s Ruffing and Horning.
Figure 1 from Ruffing and Horney, CBPP, Dec. 16, 2009.
Ruffing and Horney describe the method of calculation of the “Bush-era tax cuts” portion thus:
Through 2011, the estimated impacts come from adding up past estimates of all changes in tax laws — chiefly the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), the 2008 stimulus package, and a series of annual AMT patches — enacted since 2001. Those estimates were based on the economic and technical assumptions used when CBO and the Joint Committee on Taxation (JCT) originally “scored” the legislation, but the numbers would not change materially using up-to-date assumptions. Most of the Bush tax cuts expire after December 2010 (partway through fiscal 2011). We added the cost of extending them, along with continuing AMT relief, from estimates prepared by CBO and JCT. We did not assume extension of the temporary tax provisions enacted in ARRA. Together, the tax cuts account for $3.4 trillion of the deficits over the 2009-2019 period. Finally, we added the extra debt-service costs caused by the Bush-era tax cuts, amounting to $1.9 trillion over the period and an astonishing $350 billion in 2019 alone.
The graph makes obvious that while the EGTRRA and JGTRRA do not account for most of the deficit right now, they (in addition with AMT patches) are slated to account for a much larger proportion by FY2015, as shown in the blue area in the Figure 1.
See also Andy Samwick/CGG.
Recessionary Impact: Will the Economy Be Killed If We Return Tax Rates for the Rich back to Pre-Bush Levels?
Returning to the issue of the impact on the economy’s recovery, we have the hyperbolic (and inaccurate) headline from CNBC: “Letting Bush Tax Cuts Die Would Kill Recovery: Analysts”. The article states:
The nascent US economic recovery would be halted in 2011 if Congress fails to extend the Bush tax cuts for the wealthiest Americans, analysts at Deutsche Bank said.
Well, I’ve got the the Deutsche Bank note that the author purports to use to back up that headline in front of me. It’s a bit more nuanced than what that headline states. From C. Dobridge, P. Hooper, T. Slok, and E. Sufian, “The Growing Risk of Fiscal Drag,” Global Economic Perspectives, July 28, 2010.
Allowing the Bush tax cuts to expire will likely depress
GDP growth significantly in the near term. We have shown
in Charts 5 and 6 the estimated effects of this outcome on
the level and growth of real GDP under a range of
assumptions about the tax multiplier (from 0.5 to 1.0). The
range of possible outcomes is to depress growth in 2011
by anywhere from 0.75% to 1.5%, with a best guess of
around 1.1 (assumes multiplier of 0.75). Failure to pass an
AMT fix would mean another 0.5% fiscal drag in 2011. If
all the tax cuts are extended except that for the top income
bracket, the associated drag on growth in 2011 would be a
bit less than 0.5%. Passage of the Administration’s
proposals in full would mean drag of only about 0.25%. In a worst case scenario, allowing the Bush tax cuts to expire
and failing to fix the AMT could result in 1-1/2% of fiscal drag
in 2011 on top of the 1% fiscal drag we expect to occur as
the Obama fiscal stimulus package unwinds. If the recovery
remains soft/tentative through early next year, this additional
drag could be enough to push the economy to a stalling
point. In this light, it is perhaps instructive to consider the
Japanese experience of the 1990s.
So, if the Administration’s proposal of extending the tax cuts for two-person households with incomes less that $250,000/single person households less than $200,000 is implemented, then the impact is relatively minor, and would not “kill the recovery” initself.
I will further note that some people are misinterpreting Romer and Romer paper with respect to the impact of tax changes as supporting arguments against letting EGTRRA and JGTRRA lapse. From John Harwood in today’s NYT:
Indeed, Christina Romer, the chairwoman of the White House Council of Economic Advisers, wrote a recently published paper with her economist husband, David Romer, in which they said, “Tax increases are highly contractionary.”
Mr. Harwood should’ve read the paper more carefully (or at least the introduction). From Romer and Romer (AER, 2010):
An examination of the two types of exogenous tax changes separately
shows that tax increases motivated by a desire to reduce an inherited deficit appear to have much
smaller effects on output than tax changes taken for long-run reasons.
Well, if there was ever an inherited budget deficit, this is it (See graph below, Figure 1 from this post):
Figure 2: Cyclically adjusted budget balance as a ratio to nominal GDP. Tan shaded area, FY1994-2001; gray shaded area, FY2002-2009.Source: BEA (for GDP, 2010Q1 3rd release), CBO (for cyclically adjusted balance), and author’s calculations.
More on the the paradoxical nature of the Republican insistence on extending the tax cuts for households w/income greater than $250K, from Jeff Frankel.