Web Chat: What to Do about the Bush-Era Tax Cuts

On September 29, William Gale participated in a live web chat where he answered your questions about the expiring Bush-era tax cuts, the politics behind the actions on Capitol Hill, and the economic impact of possible outcomes. POLITICO senior editor David Mark moderated the discussion.

12:30 David Mark: Welcome to the chat. We look forward to your questions.

12:30 [Comment From Tom Mullins: ] Which is a better deal for stimulating the economy: Extending the top two rates for a year at $40Bn or Making Work Pay at $60Bn? Or letting them both expire?

12:31 William Gale: I would favor extending MWP. The reason is that right now, with the economy limping along with high unemployment, what we need is a serious boost to aggregate demand, aggregate spending. Evidence suggests — generally, but not universally — that low-income households spend a greater share of their tax cuts than do higher-income households. So, getting the tax cuts into the hands of lower income households would do more to boost the economy right now.

12:31 [Comment From Tom Mullins: ] Why has there been so little political focus on the expiration of MWP?

12:33 William Gale: Good question. It is an important potential way to get resources to low-income households which would help on both economic and humanitarian grounds. As to why it has gotten lost in the shuffle, political dysfunctionality seems like a good, if vague, answer!

12:33 [Comment From Mark Emmer: ] Government stimulating the economy does not work. It’s just a band-aid that makes our problems worse. It also encourages moral hazard, which is a big part of our current mess. Do you agree?

12:35 William Gale: No I do not. And, more importantly, virtually all serious models of the economy suggest that government stimulus does work — that is, that it helps to raise short-run GDP, which is after all what stimulus is about. It may not work as fast or as much as we would all like, but it is very difficult to construct sound arguments that suggest that stimulus policies — new government investment, new tax cuts designed to spur spending, transfers to low-income households — do not raise GDP in the short run.

12:35 [Comment From Randy P: ] It seems likely that there won’t be a vote on the tax cuts until after the elections. Don’t you think this is kind of a cop-out on the part of Congress? This is obviously a politically risky vote, but it seems pretty obvious these folks are putting their reelection campaigns over getting actual work done. What do you think?

12:38 William Gale: I agree and would say that it is actually worse than that — you are letting them off easy. They’ve known since 2001 that these tax cuts would expire at the end of 2010. They’ve had plenty of time to work on how to resolve the issue. Now, they’ve basically run out of time, without really either serious debate about the tax cuts or about the alternatives (since the real question isn’t “what should we do about the Bush tax cuts” it is rather “what is the best way to help the economy.”). I don’t “get” Congress, but it is clear to me that they can and sometimes choose to try to solve problems and sometimes they choose to keep the problem alive for political purposes. It seems like they are doing the latter here, so maybe they know what they are doing….maybe not.

12:38 [Comment From Paul: ] Do you support the idea of letting some of the tax cuts expire while extending others?

12:40 William Gale: Yes, I think the ideal approach WOULD HAVE BEEN to figure out the best options to help the economy (see answer above), but now that they have essentially run out of time, all they can do is pull things off the shelf. I would favor extending the tax cuts that help middle class and upper income households, but not extending the tax cuts that help only upper income households and — importantly — using the money saved from not extending the tax cuts that benefit only upper income households on things with more “bang for the buck” — bigger impact on the economy than the tax cuts. That would include infrastructure investment, probably aid to the states to help them stem job losses, and so on.

12:41 [Comment From A.J. (Philly): ] How do you weigh the costs of imposing more taxes on the already pressured middle class vs. the burdensome federal deficit? Will the money brought in by letting the tax cuts expire really contribute that much to closing the deficit gap?

12:43 William Gale: Right now, we need to stimulate the economy. The economy is more important than the budget. Without a strong economy we will never get the budget in line except with draconian and painful measures. So, first order of business is stimulus. As the economy recovers, we need to move toward a deficit path that generates stable debt-GDP ratios as we hit full employment (or close to it) and then stick to that path. The so-called trade-off between stimulating to help the economy and cutting back to help the deficit is not really an accurate picture of the situation, since we need to stimulate now and cut back as the economy recovers.

12:43 [Comment From Len Hillhouse: ] Do you think that increasing tax on citizens that earn over two hundred and fifty thousand a year will increase unemployment?

12:46 William Gale: “Yes, but…” is the answer and the “but” part is important. If we JUST let tax cuts expire then we will have a reduction in aggregate spending in the economy and that will hurt economic performance, raise unemployment, etc. However, if we take the same amount of money that would have gone to the high income tax cuts (ie, the tax cuts that only help high income households) and instead USE IT FOR SOMETHING ELSE then the net effect on unemployment will be to make it fall. The CBO recently examined a dozen stimulus options and ranked the tax cuts tied for last. Put differently, using the same amount of money on different things — like infrastructure, investment, aid to states, job tax credits — would create a positive stimulus effect that was larger than the negative impact of ending the tax cuts, so the net effect would be positive for the economy.

12:47 [Comment From Eric: ] How did Pres. Bush ever get away with these tax cuts in the first place? Didn’t anybody in his administration have the foresight to see that the government needed that money to keep the deficit from growing?

12:49 William Gale: In 2001, CBO officially forecast very strong deficits. Some people — myself included, in work I did with Alan Auerbach at the time — questioned the reliability of the estimates and the likelihood that things would play out as suggested by CBO. NTL, the prospect of a surplus that could be used for tax cuts had politicians in general and Republicans in particular salivating at the opportunity. Then Alan Greenspan testified in Congress that if we didn’t have tax cuts we would run out of public debt by about 2007 and one couldn’t operate monetary policy. Of course, there were other solutions to that “problem” but for the salivating politicians, it was too much temptation to resist.

12:49 [Comment From Sarah Franks: ] Hard to talk about tax cuts without also talking about deficit reduction … how serious do you think efforts re deficit reduction will be in 2011? Do you think the Fiscal Responsibility commission report will have much of an impact?

12:50 William Gale: Absolutely right. Tax cuts should never be discussed in isolation since they imply other necessary changes in policy and the money could be used for other purposes. I will be interested to see what the Commission comes up with and in particular whether they can come up with a consensus plan. If they can’t, it will make the subsequent discussion harder.

12:52 [Comment From Frank: ] There’s been a lot of chatter on the impact that expired tax cuts would have on small businesses – who are particularly struggling given the current economic situation. What’s your take on this?

12:57 William Gale: I believe that “small business” is being put out in front like a poster child for high-income households (think REALLY high-income households). The vast majority of small businesses (97 percent) would be unaffected. The standard response to that is that a lot of income from small businesses (40-50) would be affected. The problem with that argument is that a lot of that income is not really from what we would think of as small businesses — it includes some massive hedge funds, some extremely large closely held corporations, law partnerships with dozens of offices and hundreds of attorneys around the world. But, even ignoring those issues, it is important to note that many small businesses can deduct all of their investment in the first year (expensing). For them, the effective tax rate on that investment is ZERO, regardless of the statutory tax rate (because they get a deduction for the full amount in the first year). If they finance the investment with debt, and the interest is deductible, the effective tax rate is actually negative. Likewise, wages are fully deductible in first year, regardless of the statutory tax rate. And of course all of the “sweat equity” of the owner is not taxed at all until the business is sold and even then is only taxed at capital gains rates, which are much lower than regular income tax rates. So, bottom line, yes, some small businesses would have to pay more in taxes but I don’t see that as the end of the world. And, remember, other policies, according to CBO, would have a more positive effect on the economy for the same cost.

12:58 [Comment From T. Reed: ] Why were the Bush tax cuts designed to expire in 2010?

12:59 William Gale: The budget rules stipulate that if you cut taxes or raise spending beyond the next 10 years, you need a 60 vote majority for the Bush tax cuts, though they probably could have gotten it for a smaller cut. Instead, they chose to go with a bigger tax cut for a shorter period of time

1:00 [Comment From Wes: ] Generally speaking, would you expect tax cuts to be a job creator or a job destroyer?

1:02 William Gale: In our current economy, we have vast unused capacity — unemployed workers and under utilized equipment and machinery. Businesses don’t want to hire because people aren’t spending. People aren’t spending because they are worried about their jobs (ie, businesses aren’t hiring). That is a bad vicious cycle — a recipe for a low-level, high unemployment equilibrium. What tax cuts or government purchases can do is help break out of that cycle by raising spending, which could then lead to hiring, etc. A key element of that is the understanding by the business community of what the government is actually doing, since if they aren’t aware, the policy loses some of its impact on their willingness to hire.

1:02 [Comment From Eric: ] In retrospect, would you say the tax cuts were a bad decision?

1:02 William Gale: I would have said that — and did — in 2001.

1:03 [Comment From Gary: ] And would you say that the tax cuts delivered on what people thought they would accomplish?

1:05 William Gale: They certainly did not deliver on what advocates for the bill said they would. The 2001 and 2003 tax cuts focused on economic growth and job creation. We had a decade of weak growth, anemic job creation. Moreover, in the economic areas where growth did occur — like housing — the growth was not plausibly related to the tax cuts, since the tax cuts reduced the tax-favored status of housing.

1:06 William Gale: Oh, and advocates said that the pressure caused by reducing revenues would help reduce government spending, which again didn’t happen — spending went up. I think the rise in spending is plausibly related to the tax cuts since when budget discipline breaks down on one side of the budget (eg, taxes), it tends to break down on the other side too (eg, spending).

1:07 [Comment From Nancy: ] Couldn’t this whole issue be reframed? For example, instead of clamoring that “Everyone’s Taxes are Going Up!” couldn’t people simply say something like … “tax rates will return to the normal, pre-2001 level?”

1:08 William Gale: Yes, and the framing of the issue is important. One could also say “do you want to spend $3 trillion on this or on….[pick your favorite topic].” One could also say “given what we are spending now, we going to have to pay for it sooner or later, do you want to pay for it now or dump it on our kids?” As I noted above, and your question brings out, one can’t discuss tax cuts in a vacuum.

1:08 [Comment From Perry: ] Why do you think the media doesn’t put more pressure on Congress to DO SOMETHING already? It seems like news outlets tend to be critical of Obama, but Congress is the body that actually has to do the decisionmaking!

1:11 William Gale: This is a really interesting question and a hard one. I suppose it is easier to focus on one person — the President — than on an organization that has — with all due respect to the official leaders — no clear leader. Also, the President is the only national election we have — so, for example, people in one state may not care if the Representative from another state is doing a bad job. Good to think about this kind of stuff, though.

1:11 [Comment From Mark Emmer: ] We already have a debt of $40K for every man, woman and child in the country. It’s getting a lot bigger every year. (And that doesn’t even include all the unfunded liabilities at the federal, state and local level). We need to get this paid off before our children’s and grandchildren’s life is ruined. If we care so much “for the children,” why can’t we get this done?

1:13 William Gale: This is the other great issue we face. Once we do get the economy back to normal — and that will take a lot of work, still — we have to resolve medium-term and long-term deficit issues. To be clear, we shouldn’t raising current-year taxes or cutting current-year spending (on net — see discussion above about using the same amount of money as the high income tax cuts but letting them expire and spending the money on something else) but we could be designing policies now that take place in the future and start the process. The health care reform bill is one such example — IFFFFFF it is implemented as it was enacted.

1:13 [Comment From Michael: ] In your option if the MWP is extended how long should it continue?

1:15 William Gale: I really, really think we need a serious restructuring of the tax code. I don’t know if MWP makes sense as part of a permanent reform, since there are many overlapping ways to help low-income families. I’d like to see us consolidate and streamline and organize those subsidies as part of reform. In the meantime, as a stimulus program, MWP makes sense.

1:16 [Comment From Travis: ] How essential is letting the tax cuts expire to helping close the federal budget deficit?

1:18 William Gale: The tax cuts are about 2 percent of GDP every year, not counting the added interest payments they create. That is about 1/3 to 1/4 of the long-term fiscal problem, so it is a sizable chunk but not the whole answer. Making the tax cuts permanent would increase the long-term gap by more than the existing fiscal shortfall in social security.

1:18 [Comment From Henry: ] Do you think this debate over the bush taxes could fit into a larger discussion of overall tax reform? how?

1:21 William Gale: Yes, the best outcome would be if we discussed the Bush tax cuts not as a stand alone policy (should they be extended, which ones, for how long) but rather in the context of overall structure and revenue yield of the tax system. If you asked tax economists this question in 2005 (or anytime between 2001 and 2008), the “clever” answer was that by having a drop-dead expiration date, the tax cuts would force Congress to engage in serious reform discussions. Well, that was wrong (and I confess to being one of those people who thought it would actually force the issue). Clearly, Congress can be more dysfunctional then we thought. In any case, we have to eventually “do something” with the Bush tax cuts and it makes sense to think that IF we had overall reform, we would resolve that issue.

1:22 [Comment From Sarah Franks: ] To play devil’s advocate, one could argue that our deficit *isn’t* a problem (and therefore a full extension of tax cuts for another 1-3 years shouldn’t be an issue) … bond yields at 2.5% don’t help concentrate the congressional mind on the task at hand ….

1:25 William Gale: Thanks. This is a great comment, not because I agree with it, but because it raises important issues that are central to the discussion. Imagine, for a second, that one is living way beyond one’s means, putting enormous payments for parties, vacations, cars, yachts, etc. on one’s credit card with no ability to pay for those bills now or in the future. Now, imagine that the credit card company does not raise the interest rate on the person’s outstanding balance or retract the card. Does that mean the massive splurge is/was a good idea? No, of course not. The money will have to be paid back (or bankruptcy declared) even if the interest rate on the card doesn’t go up and even if credit is not denied to the partier. Likewise, we are accumulating enormous debts — more accurately, we are on the path to accumulate enormous debts. The fact that interest rates remains low tells you something about how markets operate, but does not change the fact that we have to keep our fiscal house in order or pay the price.

1:26 David Mark: Thanks for the chat, everybody.