Putting the Tax Cuts in Perspective

With Congress back in session, the mid-term election right around the corner, and a looming expiration, the debate of the 2001-2003 tax cuts is getting hotter and hotter. Up until now, the debate over the tax cuts, which are set to expire at the end of the year, has mainly centered on whether or not to extend all of them or let them expire for the highest income earners. We believe that this type of debate is missing a key component: each plan’s specific and relative deficit impact.

Some observers have decried the costs of extending the tax cuts for all earners based on the additional $700 billion in costs. Such a relative deficit view ignores the immense costs of extending the tax cuts for middle- and lower-income earners. Let’s take a deeper look at their specific and relative costs.

As can be seen by the graph below, each of the two tax cut extensions have vastly higher 10-year deficit impact than the other selected spending options enacted since the recession began. Extending all of the tax cuts will have a 10-year impact of nearly $4 trillion (when combined with annual AMT “patches”). The still incredibly expensive--yet less expensive-- partial extension would still cost over $3 trillion. In comparison, the 2008 stimulus will have a more "modest" cost of $114 billion. Even more enlightening is the fact that the partial extension is over 4 times more than the 2009 Stimulus (ARRA is now projected to cost $814 billion over 10-years) and about 50 times larger than TARP ($66 billion 10-year cost). A full extension is nearly 5 times larger than the costs of ARRA and nearly 60 times larger than TARP.

^{Note: All Others include FDIC Bank Takeovers, Housing, Unemployment, Pension and other Relief, Extended Provisions from ARRA and New Stimulus, and Credit Union Rescues--taken from Stimulus.org.}

You could also compare the cost of the tax cuts with other baseline projections of government spending. The graph below compares these plans to Social Security, Medicare, Medicaid, the defense discretionary budget, and the non-defense discretionary budget. This spending is, for the most part, more expensive than these tax cuts--except for Medicaid, which is roughly the same cost as the full extension--but it shows just how much money policymakers are talking about. Using these programs, which account for about 77 percent of all projected government spending over the next 10 years (about $10 trillion is not included in the figure), to fully offset these tax cuts, we could do the following highly unrealistic and fairly ridiculous program changes: cut about 2/3 of Medicare or the non-defense discretionary budget, about ½ of the defense budget, 40 percent of the Social Security budget, or eliminate Medicaid entirely. We don’t support doing anything this drastic to any one program, as every area of the budget must contribute to deficit reduction. We simply wish to demonstrate the size of these tax cuts to policymakers and the public.

But what about the argument that the tax cuts would increase economic growth? Well, yes, lower rates can encourage faster growth -- if they are accompanied by lower spending and/or a broader tax base. If deficit finainced, though, the negative effects of borrwing would likely overhwhelm any positive affects from reduced taxation on capital and labor. Note that when CBO looked at its Alternative Fiscal Scenario which assumes the continuation of the tax cuts (combined with a few additional practices that will further increase deficits over the coming decade), it found that:

"Over time, [as] the negative consequences of very high federal borrowing build up [under CBO's Alternative Fiscal Scenario]....real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or 'crowd out' investment in productive capital and result in a smaller capital stock."

(Note that the opposite is true in the short-run, when higher deficits are expected to have a stimulative effect on the economy).

It must be noted that CBO's Alternative Fiscal Scenario includes more than a mere extension of the 2001/2003 tax cuts. It also includes faster discretionary spending growth and fixes to the Medicare remibursement formulas. As CRFB has argued for here and here, policymakers could use the upcoming expiration of the tax cuts as a “hammer” to work out broader tax reform and/or a medium-term deficit reduction plan.