Tax renewals: buying time or a ‘permanently temporary’ fix?

WUSTL tax expert weighs in on tax cut extensions

“Although it is tempting to blame the ever-growing federal budget deficit on the recent economic crisis, the 2007-09 recession was only one of many factors contributing to staggering deficits,” says Cheryl Block, JD, federal budget and tax expert and professor of law at Washington University in St. Louis.

“Finger pointing aside, both parties have been at the helm at various times since 2001,” Block says, “both standing watch over the growing imbalance between revenues and spending and both aware of threats to the nation’s future fiscal health in light of the aging population, escalating health care costs, and growing government commitments under entitlement programs such as Social Security and Medicaid.”

Block says that legislators and their constituents suffer from a common pathology.

“We want it all: low tax rates, government spending on the programs we prefer, and — ideally — a balanced budget,” she says.

“Perhaps not surprisingly, the desire for prudent budgets increasingly loses out to the first two demands.”

Even without an extension of the 2001 tax cuts, experts have warned again and again for many years that the current economic path is unsustainable.

The Congressional Budget Office (CBO) estimates that its projected budget deficit for 2020 would roughly double, and debt held by the public would reach nearly 100 percent of the gross domestic product (GDP) if the Bush-era tax cuts were extended permanently without offsetting deficit-reducing policy changes.

“Policy makers eventually will have to face difficult decisions about changing entitlement programs and perhaps — perish the thought — increasing taxes,” Block says. “Yet, human nature — and, of course, the need for political compromise — lead us to put off painful decisions for another day.”

Block says that in this environment, temporary tax code rules have become irresistibly popular.

“To justify the two-year tax-cut extension, many argue that this simply is the wrong time to impose tax increases upon any group of taxpayers,” Block says.

“Under this view, leaving more money in taxpayers’ hands in these weak economic times will stimulate the economy and speed economic recovery. There is some truth to this claim — at least in the short-term.

“The real question is whether the resulting short-term stimulus justifies the cost,” Block says.

In a recent study, the CBO analyzed the comparative “bang-for-the buck” of several fiscal policy options. For each policy alternative, CBO’s economic impact analysis compared the estimated budget cost with the economic stimulus benefit expected from the policy change.

The report concluded that the two most cost-effective policy options were: 1) extension of unemployment insurance, and 2) payroll tax reductions.

Extension of tax cuts for the wealthy was ranked as the least effective of the alternatives studied. The CBO explained that an after-tax income increase for wealthy taxpayers would probably have little effect on the spending behavior of the rich.

Low-income taxpayers presented with a similar after-tax income increase, on the other hand, would probably quickly spend most or all of the additional income, thus increasing demand for goods and providing greater economic stimulus.

“Seen in this light, (President Barack) Obama should get more credit for making a difficult, pragmatic judgment in agreeing to the two-year tax cut compromise,” Block says.

“On the one hand, a two-year extension of tax cuts for the wealthy is wrong for at least two reasons: First, taxpayers at high income levels are not the ones struggling most in these difficult economic times. Second, the two-year tax cut extension for the wealthy would add approximately $36 billion to the federal deficit, but would provide only modest stimulus relative to alternative policies.

Block says Obama, however, saw that he did not have the votes to prevent Congress from passing at least a temporary tax cut extension for everyone, including the wealthy.

“Given this reality, Obama conditioned his agreement to the extension on including two measures that both focus more on lower- and middle-income taxpayers and provide more cost-effective stimulus: extending unemployment benefits, and reducing employee payroll taxes. In the current political climate, this is as much — and perhaps more — than could have been expected.”

Block says that the danger with this compromise, as one policy expert recently suggested, is movement toward a “permanently temporary” tax code.

“If the compromise agreement is passed, the new round of tax cuts will expire in two years,” Block says.

“Opposition to further extension of the cuts could be politically costly for members of Congress running for re-election in 2012. One silver lining, perhaps, is that temporary provisions impose a statutory deadline, forcing us to confront difficult issues sooner rather than later.

“If the extension really is temporary, and if the next two years could be spent productively considering serious entitlement, tax and spending reforms proposals, the two-year compromise deal may not be as terrible as many Democrats seem to believe — and may even offer the opportunity to really tackle the fiscal crisis that awaits the nation if it continues on its current unsustainable path,” Block says.

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