The Bush Tax Cuts

Posted by Don Fullerton on Oct 8, 2010

Filed Under (U.S. Fiscal Policy)

Editor’s note: With Bush-era income-tax rates set to expire, Democrats want to return the rates that high-earners pay from 33 and 35 percent to Clinton-era levels of 36 and 39.6 percent. Republicans counter that raising taxes during a recession would bring an already sluggish economy to a standstill. Finance professor Don Fullerton, a former deputy assistant secretary of the U.S. Treasury Department who studies tax policy issues at the U. of I. Institute of Government and Public Affairs, discusses the potential impact in an interview with News Bureau reporter Phil Ciciora.

What are the big-picture economic implications for extending the Bush-era income-tax rates?

The question is complicated, because the choice is not just between extending the Bush tax cuts or letting them expire. A lot of other options are available. In particular, President Obama would make the tax cuts for lower- and middle-income families permanent – specifically, those who make less than $250,000 per year – while letting tax cuts expire for those making more. In other words, let the tax rates go back up to their previous level for the rich, but keep the tax cuts for everyone else.

A lot of the discussion relates to the business cycle and recession, but I think that discussion is misplaced. No extra stimulus is provided by cutting taxes on the rich more than on the poor. The real issue here is distributional fairness – who ought to bear more or less of the tax burden – and that’s a topic about which economists do not have any special expertise. Whether we should take more or less from the rich or from the poor or middle class is an issue of social justice rather than economic policy.

And those questions of social justice don’t have anything to do with the recession. More important for the recession is whether to cut tax rates, or to increase government spending, or to provide some other temporary tax relief. Some of the suggestions would temporarily allow businesses to expense investments immediately instead of taking depreciation deductions over time. All of those topics are mixed together in this debate.

Advocates for sun-setting the tax cuts argue that taking taxes back to Clinton-era levels for those making more than $250,000 might actually stimulate growth by decreasing our deficit. Proponents of keeping the rates the same say raising taxes during a recession would cause consumer spending and investment to dry up. Which side is correct?

The semantics here are somewhat confused.

We’re not really raising taxes relative to current law; maintaining current law means that the rates will rise at the end of 2010. That is the law passed during the Bush administration, namely, that rates would fall for 10 years and then rise again.

However you want to frame the argument, allowing higher rates just on those making more than $250,000 is not a huge tax increase that would injure the recovery or extend the recession. By the same token, taking a bit more from the rich by letting their tax cuts expire – that alone won’t cut the deficit or make the recession any better either. It’s just not going to have that huge of an impact. More impact on the recession would be provided by other options, such as extending unemployment compensation, stimulus spending on infrastructure, or faster depreciation deductions.

A lot of this debate is coming to a head, obviously, because of the mid-term elections.  Maybe some of these choices should have been made earlier, in the original stimulus bill. And if Congress does nothing, then all the tax cuts will expire, with a large impact that might slow the economy. But if politicians agree on keeping most of those tax cuts, then I don’t think our hopes of revitalizing the economy depend on keeping all of them.

One of the arguments for extending the Bush tax cuts or even making them permanent is that businesses and individuals need tax certainty. Is that a valid argument?

No, I think that’s wrong. Right now things are uncertain, but that uncertainty could be resolved by making any tax rates permanent. It doesn’t mean the lower rates must be made permanent.

It was the original tax bill 10 years ago that provided this uncertainty. In that bill, Congress played a cheap trick. The bill was to written to make the budget numbers look better than they really were. Politicians wanted to cut tax rates, for political reasons, but they didn’t want to appear irresponsible by causing a long run budget deficit with huge fiscal problems down the line. So they decided to have their cake and eat it, too, by enacting a tax cut that would expire in 10 years. The tax cut gave them the political gains they wanted, and providing for the expiration of those tax cuts would make the long run budget look good. Yet nobody ever really thought that the politicians who come along later would allow all those tax cuts to expire! So, those earlier politicians could get their own political gains from the tax cut, and appear to be fiscally responsible, but they left the later politicians between a rock and a hard place. Current politicians now must hurt themselves by allowing the tax cuts to expire, or else hurt themselves by adding to the huge budget deficit.

In other words, the decision 10 years ago was cynical, and it was completely disingenuous; they passed a law saying the tax cuts would expire, but they knew the tax cuts would not expire. It’s a Ponzi scheme. Didn’t Bernie Madoff go to jail for that?

One Response to “The Bush Tax Cuts”

  • Jeff Brown says:

    Hi Don. Good interview. Now, to try to get some conversation going (at least between us!) … you state that “no extra stimulus is provided by cutting taxes on the rich more than on the poor.” This statement assumes that the marginal propensity to consume is unrelated to income. Interestingly, many Democrats (such as Jason Furman, who is now deputy director of Pres. Obama’s National Economic Council) argues that the poor would be more likely to spend tax rebates than the rich. But a paper published in last year’s NBER Tax Policy and the Economy found the opposite – namely, that the poor were more likely to pay off debt, and those with higher incomes were more likely to spend the money. Doesn’t this mean that the short-term stimulative effect of tax cuts does depend on who gets the cut? And over the longer term, if the labor supply of high earners is more elastic than low earners, does that not also imply efficiency differences based on who gets the cut?