Yes, Actually, We Should Pay for the Tax Cuts

An article in The Hill today notes that House Republicans do not plan to offer offsets for the extension of the 2001/2003 tax cuts that expire at the end of the year. The tax cuts are the largest part of the fiscal cliff, representing a $435 billion hit to the economy over the next two years (although we have noted previously that the policy is not a particularly cost-effective form of stimulus).

Still, short-term economic concerns should not be an excuse to simply add to the deficit. Just as we said two weeks ago, the tax cuts should be paid for if not dealt within the context of an overall deficit reduction plan. Unlike the small business tax cut, not paying for this one would have huge implications for fiscal policy. Of course, the House majority is not alone in wanting to extend the tax cuts: the Democrats' main position is to extend them for everyone making less than $250,000. Either way, the tax cuts should be dealt with in a responsible manner.

Extending the tax cuts by themselves will cost $2.8 trillion over ten years, while extending only the "middle class" tax cuts will cost $1.9 trillion. Assuming that Alternative Minimum Tax patches were already in place, the extensions would cost $3.8 trillion and $2.8 trillion, respectively, due to interactions with the AMT.

For context, we have graphed what debt as a percent of GDP would be under different policies. If the tax cuts were extended, the AMT was patched, physician payments were frozen instead of cut, war spending was drawn down as scheduled, and the sequester was repealed, debt would be 85 percent of GDP in 2022. If all of those policies happened except the tax cuts for people making more than $250,000, debt would be 81 percent in 2022. If all the tax cuts expired but the other policies were kept, debt would be 67 percent in 2022. Finally, if all of those policies expired, debt would be at the current law level of 61 percent.

One House member is quoted in the article as saying "It's not a pay-for situation. It's just a strong policy that needs to be adopted." We think the opposite is true: if it's such a strong policy, it should be easy to find a way to offset the costs in a responsible way.