Should we Extend the Bush Tax Cuts?

Carl Milsted, Jr on May 7 13:26:04

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Originally published December 12 2010

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!