Let the Tax Cuts Lapse

What she said:

Given the deficits we have, until we find and enact actual offsetting spending cuts (no, I don’t want to hear any more about starving the beast), those tax cuts have to go. And a temporary extension is simply going to make it harder to let them expire next year, for the same reasons that the AMT keeps getting “fixed” on an annual “temporary” basis. It is going to be hard enough, psychologically, for people to give up tax breaks they have had for ten years. Stretching it out longer just makes the pain more fierce.

If you’re worried about the macroeconomic effects, then enact a different temporary tax cut that helps many of the same people–payroll cuts, high standard deductions, a rebate, whatever. But don’t let a tax cut we can’t afford live so long that it becomes immortal.

I was opposed to the “Bush tax cuts” from the get-go, not because I’m opposed to tax cuts but because I didn’t see a decline in consumer spending as causing the economic downturn of the early 2000s but rather a decline in business spending. I think that’s still the case.

If President Obama wants to shake the idea that he’s anti-business and he’s worried about the macroeconomic effects of a tax increase (yes, letting the tax cuts sunset is a tax increase), let him get behind replacing the cuts in the personal income tax with allowing current year expensing of all business purchases other than real estate. That’s what every other OECD country does.

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    Megan McArdle: If you’re worried about the macroeconomic effects, then enact a different temporary tax cut that helps many of the same people–payroll cuts, high standard deductions, a rebate, whatever. But don’t let a tax cut we can’t afford live so long that it becomes immortal.

    Okay, if we can’t afford the Bush tax cuts, we also can’t afford any of the other policies she proposes. In particular, cutting payroll taxes REALLY won’t help our situation – SS and Medicare both have immediate funding problems. The only way to ‘pay’ for those is to keep borrowing. That seems little different than the Bush tax cuts.

    For that matter, the entire income tax system is badly broken, Bush tax cuts or not. Obama’s income tax shenanigans led me to spend almost 20 hours working on my mother’s taxes this year – for $11,000 of taxable income! I still never quite got it correct, and had to pay $46 that legally she shouldn’t have had to pay. (Long story, not worth the effort to explain.)

    Bush’s tax cuts, Obama’s tax “rebates”, and the income tax system are all symptomatic of a federal government that simply fails to execute its responsibilities. The tax code should not be this complex – a great deal of the complexity comes from special pleading from favored groups manipulating the code for their own purposes.

    The entire federal tax system should be overhauled. (And those that created the current system should all be keel-hauled at least.) We need something much more easily understood and more easily implemented. Perhaps it should be a flat tax, or maybe a VAT, or the so-called ‘Fair Tax’. Hell it could even be an income tax with a vastly simplified code, though I suspect in five to ten election cycles that would be nearly as complex as it is now. (I favor the ‘Fair Tax’ currently. For one reason it will be somewhat less ammenable to the political BS that has made the income tax such a beast.) But what we have now couldn’t have been designed worse if it had been meant to wreck the nation.

  • Okay, if we can’t afford the Bush tax cuts, we also can’t afford any of the other policies she proposes.

    I think she’s trying to make a distinction between a permanent tax cut and a temporary one. A key problem is that temporary tax cuts don’t have fiscal stimulus effects.

  • If we can’t afford to cut back on the stimulus spending we can’t afford to let the tax cuts lapse.

    We have a truely horrible fiscal situation. Cut spending one side says and you’ll risk sending the anemic recovery into recession again. If you let the tax cuts expire same thing. The anemic nature of the recovery is likely to last for a number of years. Unemployment didn’t really peak during the last, extremely mild, recession for several years after the recession ended. Will we repeat or go even longer?

    A key problem is that temporary tax cuts don’t have fiscal stimulus effects.

    A key component of a permanent tax increase is that they DO have a contractionary effect. Don’t believe me? How about <a href="http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf"Christina and David Romer?

    It also allows us to further separate legislated changes into those taken for reasons related to prospective economic conditions, such as countercyclical actions and tax changes tied to changes in government spending, and those taken for more exogenous reasons, such as to reduce an
    inherited budget deficit or to promote long-run growth. We then examine the behavior of output following these more exogenous legislated changes. The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases
    designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

    The explanation for the last part is that the benefit to lower interest rates due to deficit reduction offsets the output loss due to higher taxes. Problem right now is that interest rates are pretty low. So if interest rates are currently low and we raise taxes to reduce the deficit can interest rates go even lower?

  • Well messed up the link.

    <a href="http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf"Christina and David Romer

    There we go…

    Interesting paper in that they note the issue with using fiscal policy (spending and tax changes) in response to changes in the economy. Namely the long lag time between when the economy “turns” and when fiscal policy can be implemented.

  • Okay I fail at making links…I give up. Just copy and paste if you want to read the article.

  • It’s not surprising to me, Steve. Even had I not read the study it wouldn’t have been surprising. I think a lot of this economic engineering boils down to time-shifting and the rub is that you’re time-shifting from somewhere upstream to now. We’ve been time-shifting for 70 years. Now we know where we’ve been time-shifting from.

    My preference would be fiscal soundness and leave well alone. That’s politically impossible because the temptation to do something is irresistible.

  • I agree Dave, and I think we have to face the fact that we really have put ourselves in a predicament. We can’t keep time shifting income/resources forever. Capital markets are not perfect and there is a limit and we may well be hitting it.

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