Letting Bush tax cuts die would be a good riddance

By Neeraj Salhotra     10/21/10 7:00pm

The Bush tax cuts that were enacted in 2001 are set to expire at the end of this year. There has been much discussion about what action should be taken: Make the cuts permanent, extend them for two years, maintain the cuts only for lower-income Americans or just let them expire completely? While there is no obvious option, let me offer two solutions. The first, and more preferable, is allowing the tax cuts to expire while also using a small part of the generated revenue to enact a government stimulus program. The second, and somewhat less politically divisive option, is to extend the tax cuts for two years for Americans making less than $250,000 yearly.

Let us examine each potential solution in turn. If we let the Bush tax cuts expire and apportion part of the revenue to enact a second stimulus, we will address our deficit issue and create jobs for millions of Americans.

Currently, the U.S. deficit is more than 10 percent of its GDP. By removing the tax cuts, government revenue will increase by $3 trillion over 10 years and, as Peter Orszag, former head of the Office of Management and Budget, noted, "will reduce our deficit to a sustainable 3 percent of GDP [.] and pretty much solve the deficit problem in the medium term."

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On the contrary, if we extend the tax cuts, Congressional Budget Office Director Doug Elmendorf noted that our economy will not be helped in the long run. In fact, he said, "Lower tax revenues will increase budget deficits and thereby government borrowing, which crowds out investment." Simply put, extending the Bush tax cuts augments the U.S. deficit crisis and hurts the U.S. economy in the long run. The most common argument against allowing the tax cuts to expire is that during a recession, tax increases hurt Americans who are already struggling. This is true to a certain extent - removing tax cuts will hurt some Americans - but maintaining the tax cuts is not the best means of helping Americans regain their jobs and livelihoods. A substantial public works stimulus is the most economically efficient way to provide jobs to millions of Americans. U.S. unemployment is the result of low aggregate demand. Tax cuts, while somewhat stimulating demand, are much less effective when compared with government spending. According to the CBO, the estimated fiscal multiplier for tax cuts is 1.1 - in other words, if you spend $1 on tax cuts, consumption increases by $1.10 - as compared with 1.8 for government stimulus. Therefore, government spending through a public works program is a more effective stimulus than tax cuts.

Realistically, Congress will allow for neither the complete expiration of the cuts nor the creation of a second stimulus. Thus, we must consider another, somewhat less partisan option: a partial extension of the Bush tax cuts for two years for those Americans earning less than $250,000.

Such an extension would both partially address the deficit and provide a small stimulus to the economy. According to estimates, ending the Bush tax cuts for the wealthiest 2 percent of Americans will increase government revenue by more than $700 billion. While this does not address our deficit problem completely, it does take a step in the right direction.

Additionally, maintaining tax cuts on the richest Americans has little to no effect on stimulating the economy. Wealthy individuals have a lower marginal propensity to consume and increases in income do not lead to significant increases in spending. However, tax cuts on lower income Americans, whose marginal propensity to consume is higher, will lead to increased aggregate demand and by extension less unemployment. Thus, while extending the tax cuts for two years on American households earning less than $250,000 annually is not a perfect solution, it does take small strides in both reducing the deficit and stimulating the economy.

The U.S. faces the problems of both high unemployment and a mounting deficit. Nonetheless, we have been presented with a unique opportunity to address both problems: Let the Bush tax cuts expire and use a small fraction of the revenue toward a government stimulus. Increasing taxes will create more than $3 trillion in government revenue and will significantly solve our deficit issue. A small stimulus will not have a huge effect on the deficit but, if targeted and spent wisely, can substantially reduce unemployment. So, Congress, let the Bush tax cuts expire and enact a second stimulus.

Neeraj Salhotra is a Sid Richardson College sophomore.

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