What if the Bush tax cuts lapse?
The tax cuts at the heart of a fierce pre-election battle on Capitol Hill were designed when the economy was booming, the federal budget was in surplus and George W. Bush was campaigning for president on a promise to return the extra cash to taxpayers.
Today, the economy is sluggish and the national debt is soaring to worrisome levels. As lawmakers bicker over whether to extend the Bush-era tax cuts, not just for the middle class but also for the wealthy, many economists and budget analysts say there's a simple way to curb borrowing: Let the tax cuts expire for everyone.
Official and independent budget estimates show that letting tax rates spring back to pre-Bush levels for all taxpayers would bring the country within striking distance of meeting President Obama's goal of balancing the budget, excluding interest payments on the debt, by 2015.
"If we actually ended the Bush-era tax cuts, that would pretty much do it," Obama's recently departed budget director, Peter Orszag, said in an interview last week with CNN's Fareed Zakaria. "If you do a bit on the spending side and then end the tax cuts, you pretty much get there."
But for all the election-year hand-wringing about deficits, no one in Washington is talking about letting the tax cuts lapse on schedule in January. Instead, Senate Republicans have offered a measure that would extend all the cuts, adding nearly $4 trillion to the debt over the next decade. This week, Senate Democrats say they plan to unveil a bill that would preserve most of the cuts for most Americans. That would add nearly $2 trillion to deficits by 2020.
Obama argues that allowing the cuts to expire for the wealthiest 3 million taxpayers - one of the chief differences between the two Senate proposals - is more fiscally responsible than the GOP's position. "The first thing you do when you're in a hole is not dig it deeper," he said at a town hall meeting Monday in Washington.
But the Democrats' plan also represents a pretty big shovel, budget analysts said.
"Both parties are being disingenuous here," said Robert Bixby, executive director of the nonprofit Concord Coalition, which advocates balanced budgets. "When I hear the Democrats saying Republicans are willing to add to the deficit, well, the Democrats are willing to add $2 trillion to the deficit themselves. The Democrats are doing almost as much damage to the deficit as the Republicans are."
Although the down economy might offer good reason to keep tax rates low for another year or two, putting more money in the hands of consumers, Bixby and other budget experts say it makes no sense to maintain that level of taxation permanently when the government is borrowing more than 40 cents of every dollar it spends.
The nonpartisan Congressional Budget Office predicts that the economy would be stronger with the cuts, but only through 2012, when the extra borrowing they require "would reduce or 'crowd out' investment in productive capital." Even former Federal Reserve chairman Alan Greenspan, an early advocate of the cuts, now says Congress should let them expire.
"I am very much in favor of tax cuts, but not with borrowed money," Greenspan said in an interview last month.
The budget outlook was far rosier when Bush conceived the cuts, which were one of the biggest tax reductions since World War II. Thanks to tax increases and robust economic growth, the Clinton administration had balanced the budget for the first time since the 1960s and was starting to pay down the national debt.
Bush pushed the cuts through a Republican Congress in 2001 and 2003, lowering levies on inherited estates, dividends, capital gains and income at all levels. He wiped out a de facto tax penalty on married couples filing jointly, doubled the child tax credit and created a 10 percent tax bracket at the very bottom of the income scale. At the upper end, he cut the top rate from 39.6 percent to 35 percent.
Lawmakers also revised the alternative minimum tax (AMT), an expensive parallel tax structure that would otherwise have deprived millions of people of the benefits of the cuts. That added billions more to the cost.
What would it cost to keep the cuts now? Preserving them all, with the AMT fix, would reduce revenue by nearly $3.9 trillion over the next decade, according to the CBO. The extra borrowing would tack an additional $1 trillion onto the nation's interest payments, the CBO says.
Defenders of the tax cuts say that those costs are irrelevant and that the real problem is rising levels of federal spending.
"Washington is scheduled to spend $46 trillion over the next decade. I wish the people who are focusing on criticizing the tax cuts would focus on the $46 trillion in runaway spending," said Brian Riedl, a budget expert at the Heritage Foundation. "The numbers are very scary, and even economically painful tax increases will not make a very large dent in the budget deficit."
But a paper to be released Tuesday by the Center for American Progress (CAP) shows how difficult it would be to stabilize the debt solely through spending cuts. If all the tax cuts were extended, Congress would have to cut $325 billion in 2015 alone to get the deficit down to Obama's target of 3 percent of the gross domestic product. If the cuts were preserved only for the household incomes less than $250,000 a year, as Obama has proposed, Congress would still have to cut $255 billion.
A one-year reduction of either size would amount to the sharpest cut in federal spending "since the military demobilization after World War II," said Michael Ettlinger, the paper's co-author and CAP's vice president for economic policy.
Ettlinger and co-author Michael Linden conclude that closing the gap would require "really painful and politically difficult" actions, such as slashing highway funding and agriculture subsidies by two-thirds and taking deep bites out of Pell college grants, the Pentagon, housing assistance - even Social Security.
Ettlinger is not among those who call on Obama to let the Bush tax cuts expire, saying it would break the president's campaign pledge to protect the middle class. Still, he added, "we're going to have to put revenue on the table."
So far, neither the White House nor congressional leaders have come up with a plan to avoid trillions in fresh borrowing if the tax cuts are extended - and that's making moderates in both parties nervous. After Senate Minority Leader Mitch McConnell (R-Ky.) put out his nearly $4 trillion tax plan last week, several Senate Republicans said they would prefer a less expensive temporary extension of two to three years.
Meanwhile, more than 30 House Democrats have signed a letter calling on Speaker Nancy Pelosi (D-Calif.) to consider extending all the cuts temporarily - a plan that would not only cost less but also let them avoid raising taxes on the wealthy in an election year.