Should we Extend the Bush Tax Cuts?

Our national debt is nearly as large as our GDP, and it is growing at a rate of 10% per year. So what are they debating in Congress? Extending the Bush era tax cuts.

Dumb!

Don’t get me wrong. I’d love to see lower taxes – if we had enough spending cuts to go with those tax cuts. No one is talking that kind of spending cuts. Cut $1.3 trillion dollars per year in the budget and I am open to some small tax cuts.

Small.

In my book paying down the debt takes precedence over tax cuts and economic growth. Yes, we are in a recession, but the economy is scheduled to get worse. This is not mere crystal ball gazing. It is simple demographics. The Baby Boomers will retire soon. Retired people don’t produce all that much. Our economy is scheduled to have reduced overall productivity in the not so far future. We need to be paying down the debt now while the Boomers are still on the job.

So what are we doing? We are running record deficits – both trade and budget. And we are doing so not to fight a desperate world war, but merely to subjugate some primitives in the mountains of Afghanistan, and quell a potential civil war in Iraq. There is no excuse for running a deficit in these circumstances. We’ve had some sort of conflict with outgunned peoples throughout most of our history. The level of war we are at is the American norm. We should budget accordingly.

Many Republicans would whine that we need to extend the tax cuts to make the economy grow. Let’s be real. The debt is growing at 10% annually. Does anyone seriously expect the economy to grow at 10% per year if we nibble at taxes? And 10% GDP growth merely makes us break even on the debt/GDP ratio.

Even if levying a hundred billion extra dollars costs the economy a hundred billion dollars of growth, I’ll take the levy. The debt is as big as the economy.

But I don’t think that is our choice. We are below the Laffer Curve maximum for taxing the rich these days. (We might be above the Laffer maximum for corporate tax rates, but that’s a story for another day.) The economy grew just fine under the taxes raised under Bill Clinton. And let us keep in mind that the taxes raised don’t just disappear from the economy, they return in the form of less borrowing by the U.S. Treasury. When banks can’t make money buying government debt, they have to find consumers and businesses to lend to. This can grow the private sector economy.

While this is no time for tax cuts, it is a good time to think about tax simplification. We could merge FICA into the income tax to have a nice simple two or three bracket tax code. We could use a national sales tax and/or a carbon tax to supplement the income taxes. We could raise money be closing loopholes vs. raising marginal rates.

And yes, we should also cut spending. But the strategy of forcing spending cuts by cutting taxes is a proven failure. It is time for Republicans to listen to their grownups such as David Stockman.

Some Room for Hope

After re-reading the above I realized that I made an overly pessimistic assumption: I neglected inflation. We don’t need 10% real growth in GDP to keep up with the deficit, just 10% nominal growth. If the economy grows at 4% in real terms and we have 6% inflation, then we break even. For those years where we get less than 4% real growth we’d need more inflation just to break even.

But we need to do more than break even! We need to lower the debt/GDP ratio now to prepare for the aging Boomers. So we’d need even more than 6% inflation coupled with decent real growth. So if you don’t like the Stockman solution you have another: get a leisure suit. It’s Carter time!

5 Responses to Should we Extend the Bush Tax Cuts?

  1. D.A. Sawyer says:

    I couldn’t agree more. Cutting taxes doesn’t make a difference if spending is not also cut. The government will get the resources necessary for its level of spending one way or another, borrowing only increases the income gap between the financial community (ie. those who have money to buy treasuries) and working people (ie. the people who will be paying the interest to the former). Inflation is another option: a regressive tax. Neither is a better option than allowing some portion of the income tax to go back up.

    But realize: Obama is simply playing according to the Keynsian playbook. Running up record deficits is precisely what the doctor orders when there is a deep recession… just the doctor’s a quack, that’s all. They keep trying to prime the pump, not realizing that the problem is that the water table dropped below the bottom of the well, on account of excessive use caused by deliberate overestimation of how much was left. The only thing to do is conserve like mad until the water table recharges enough.

  2. rightwinger says:

    This blogpost was pretty informative. Dan Mitchell of the Cato Institute has a pretty cool lecture series on the Laffer Curve. You might want to check it out. Here it is (in 3 parts):
    http://www.youtube.com/watch?v=fIqyCpCPrvU
    http://www.youtube.com/watch?v=YsB_rnzBA08&feature=channel
    http://www.youtube.com/watch?v=Mw7LtVwDCbs&feature=channel

  3. Carl Milsted Jr says:

    Nice videos, rightwinger. After playing around with the existing tax code a bit more, I think a 30% flat tax with a $2500 per adult rebate would pretty much match what we have today. I’ll post on it later. My last post on the subject didn’t take into account the impact of itemized deductions.

    My flat tax merges payroll into the income tax, which is why my rate is higher than the 17% Dick Armey promotes.

    As for capital gains. When the tax code favors capital gains, people structure their payments to look more like capital gains than ordinary income. The loss of capital gains taxes when capital gains are taxed at the same rate as ordinary income does not mean less income for the government necessarily. Some of that income simply gets converted to ordinary income.

  4. The reason tax cuts on the rich could take place is that the Fiscal Commission attracted votes of a majority of its members on tax reform and spending cuts. Had it been deadlocked, I don’t think Obama would have cooperated with extending the tax cuts. Indeed, if the tax cuts had not been extended, the Fiscal Commission cuts would not be necessary.

  5. Ailbe says:

    Paul Ryan promotes essentially a 25% flat tax but I’m not sure what deductions are involved (actually it’s 10% + payroll tax @25%) up to @ where payroll drops off and 25% thereafter.

    Of course he seeks to replace corporate income taxes with a consumption tax.

    You don’t mention deductions per say, but basically by “rebate” you mean that the federal tax wouldn’t kick in until your income taxes due = $2,500.01 per adult… right?

    I’m wacky enough that I’d like to consider a Georgist approach to taxation instead of personal income taxation for reasons Gaffney lists here:

    http://www.usbig.net/papers/195-Gaffney–George's%20Economics%20of%20Abundance–Apr09.pdf

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