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Tax Cuts May Come At a Price, Study Says
Treasury: Financing Must Be Found

By Nell Henderson
Washington Post Staff Writer
Wednesday, July 26, 2006; D01

The federal government will need to either cut spending or raise taxes down the road to pay for extending President Bush's recent tax cuts, the Treasury Department said in a report released yesterday, dismissing the idea popular with many Republicans that such sacrifices can be avoided.

The Treasury report did not openly address the much-debated contention of many conservative analysts that the tax cuts will boost economic growth so much over time that the resulting increase in taxes paid will offset much or all of the initial loss in government revenue -- that tax cuts can essentially pay for themselves.

The report acknowledged the debate delicately, saying "the issue of how, or even if, these policies need to be financed remains a source of discussion among economists."

But the Treasury's view reflects "a recognition the federal government has to finance the tax relief" to avoid a rise in government debt, Robert Carroll, deputy assistant secretary for tax analysis, said in an interview.

The report stressed that the economic effects of extending the tax cuts "depend crucially on whether they are financed by lower spending or higher taxes in the future."

One of Bush's top legislative goals is persuading Congress to make permanent several provisions of his 2001 and 2003 tax-cut packages that are set to expire in 2010. They include lower tax rates on income from wages, dividends and capital gains; a doubling of the child tax credit; and a reduction in the tax disadvantages of marriage.

If those tax cuts are extended and matched by comparable reductions in government spending, under the best scenario, the nation's level of economic activity would be increased by about 0.7 percent per year over time, or by $90 billion a year in current dollars, Carroll said.

If the government instead decides to raise taxes later, effectively making the tax cuts temporary, that could lower economic output over time, the report said.

"The report clearly indicates tax relief means more economic growth under certain conditions," Carroll said. "If the tax relief is not permanent, they might actually have adverse effects on growth."

The Treasury report was its first using "dynamic analysis," an approach that looks at how tax changes alter consumer and business behavior in ways that affect the economy's growth.

A reduction in income tax rates, for example, might initially reduce the government's revenue, but over time might encourage more people to work, and to put in longer hours, increasing tax payments to the government over time.

The Congressional Budget Office and Congress's Joint Committee on Taxation provide dynamic analyses of how changes in tax policy are likely to affect the economy but do not use "scoring," which estimates the effects of tax changes on the governments tax receipts.

Earlier this year, Bush's budget proposed creating a Treasury Division on Dynamic Analysis to refine its approach, saying, "It is envisioned that dynamic analysis eventually would evolve into dynamic scoring."

The Treasury report released yesterday relieved "a lot of fears that dynamic scoring would lead to the view that cutting taxes raises revenue," said Jason Furman, a senior fellow at the liberal Center on Budget and Policy Priorities. Rather, the report "pours a huge bucket of cold water on the exaggerated claims that tax cuts transform the economy and pay for themselves."

On the contrary, Furman said, the Treasury's estimates suggest that, under the best long-run scenario, the tax cuts' boost to tax payments would offset less than 10 percent of their initial cost.

The Treasury report highlights Bush's call for both permanent tax cuts and "spending restraint."

But government spending has increased sharply during the Bush administration, said Leonard E. Burman, director of the Urban Institute's and the Brookings Institution's joint Tax Policy Center. He faulted the White House for deferring discussion of the types of big spending cuts that would be required to finance the tax cuts.

"All of the hard questions are swept under the rug," said Burman, a Treasury official in the Clinton administration. "We've increased spending and cut taxes, which is politically a very effective strategy. But in the long run, the effect on the economy is a disaster."

© 2006 The Washington Post Company