April 18, 2014

Those "Best-for-Nothing" Bush/Obama Tax Cuts

The media is buzzing about how House Minority Leader John Boehner and President Obama might be ready to "compromise" on what to do about the Bush tax cuts.  From a story by Shailagh Murray and Lori Montgomery in Monday's Washington Post:

House Minority Leader John A. Boehner (R-Ohio) surprised Democrats on Sunday when he said he might not oppose President Obama's plan to extend the cuts for all but the wealthiest households, although he reiterated his preference for keeping the lower rates in place for all income groups.

Boehner's comments, made on the CBS program "Face the Nation," altered the landscape of the tax debate by suggesting that Republicans might not obstruct Democratic efforts to raise taxes on the top earners - a move advocated by Obama and many other Democrats as necessary to lowering the record deficit.

But read on in the same story.  Boehner did not say he would support letting the top-end cuts expire.  He said he wouldn't oppose extending all the rest of the tax cuts that President Obama is already proposing to extend:

"If the only option I have is to vote for those at [$250,000] and below, of course I'm going to do that," Boehner said. "But I'm going to do everything I can to fight to make sure that we extend the current tax rates for all Americans."

And Mike Allen from Politico clarifies Boehner's intention by quoting a Boehner aide:

A Boehner aide reads between the lines: “Despite what Obama says, Republicans are not holding middle-class tax cuts hostage and we're not going to let him get away with those types of false claims. Our focus remains on getting bipartisan support for a freeze on all current rates, because that is what is best for the economy and small business job creation. Boehner's words were calculated to deprive Obama of the ability to continue making those false claims, and as a result we are in a better position rhetorically to pressure more Democrats to support a full freeze.”

In other words, this is the same kind of "compromise" on fiscal policies we've seen in Washington for the past decade:  "I'll let you have your favorite deficit-financed policies (even those I don't like) if I can have some of mine (that you don't like), too."

And more proof that this is what is likely to happen, from both sides of the "compromise"?  Later in the Washington Post story:

Senate Majority Leader Harry M. Reid (D-Rev.) and House Speaker Nancy Pelosi (D-Calif.) are pledging to back the president's position as in sync with the views of a majority of Democrats in each chamber. But amid signs of a weakening economy, a growing number of Democrats would prefer to extend all tax cuts, at least for a year or two - a compromise that Obama did not explicitly rule out during his news conference on Friday. Another approach that is gaining traction would raise the $250,000 income threshold to $1 million per household, to exempt families who live in regions with high costs of living.

Yep.  That's right.  The "middle class" might just become any family with an annual income of up to a million dollars.

Republicans know this is a great way to keep getting their way on "tax cuts all the time for any reason."  Newt Gingrich seems downright giddy about it (again from the Post story):

"Republicans would be very wise to say, 'We will pass any tax cut this president will sign as long as it doesn't have a poison pill of a tax increase,' " former House speaker Newt Gingrich told "Fox News Sunday."

And what about the argument that at least some extension of at least some of the Bush tax cuts is necessary given the still-fragile economy?  And the argument that deficit-financed tax cuts are the only kind of stimulative fiscal policy that the Obama administration and Congress will be able to agree on?

Well, even if we had to limit the universe of possible fiscal stimulus policies to tax cuts alone (and no spending programs), the Bush cuts--and even the "middle-class" Bush cuts -- are far from the most stimulative options we could come up with.  See, for example, this testimony by CBO director Doug Elmendorf which lists these tax-cut options as offering more short-term economic "bang per buck" than continuing the Bush tax cuts (reducing income taxes). They are, in descending order of effectiveness:

  1. reducing employers' payroll taxes (whether for firms that increase their payrolls, or more generally)
  2. reducing employees' payroll taxes
  3. providing additional refundable tax credits for lower- and middle-income households in 2011
  4. allowing full or partial expensing of investment costs

What higher "bang per buck" in terms of short-term fiscal stimulus (boosting aggregate demand) means is that you could achieve one of the following: (i) a larger increase in GDP for the same amount of money as the cost of extending the tax cuts; or (ii) the same increase in GDP for a smaller amount of money compared with extending the tax cuts.  Or any combination in between.  The point is: more benefits at lower cost.  (That's what economists call "optimizing.")

What about looking beyond the next couple years to when we're back toward full employment: What fiscal policies would be best for increasing our productive capacity and hence longer-term economic growth?  Well, here's where deficits matter -- in a bad way.  If tax cuts designed as stimulus are allowed to become permanent deficit-financed tax policy, then it ought to be because their benefits in terms of encouraging greater private-sector economic activity via labor supply and savings outweigh their costs in terms of higher deficits directly reducing national saving.  The problem here is that a permanent extension of the Bush tax cuts would cost trillions of dollars (adding trillions to federal deficits and accumulated debt), while the benefits in terms of encouraging the supply side of the economy would be comparably small.  That's because the economic difference between extending the Bush tax cuts or letting them expire, in terms of effects on marginal tax rates and the breadth and efficiency of the tax base, is very small.  The largest economic effect of the Bush tax cuts is their negative effect on national saving.  As I have written recently on my EconomistMom.com blog, if we really want to use federal tax policy to encourage longer-term economic growth, we should engage in fundamental tax reform that broadens and levels out the tax base, and at the same time doesn't cut tax revenues but actually raises them to more adequately cover our ongoing and growing spending needs (which will be growing even with successful health care reform).  And by the way, President Ronald Reagan may own the reputation of being the biggest tax-cutter in American history, but, ironically, he was more willing to reverse his own tax cuts when the deficit became a problem than President Obama is now willing to let President Bush's tax cuts expire.

Extending the Bush cuts and turning them into the new "Obama tax cuts" would have some benefit to the economy.  But for whatever economic goal you can think of, whether short-term or longer-term, there's some fiscal policy even better suited for that goal.  So the Bush/Obama tax cuts aren't "good for nothing."  They're just "best for nothing."  And as constrained as we are, we should be aiming at least to do better.