Let the Bush tax cuts expire, there are better options

One of the unfortunate side effects of the political dysfunction that has increasingly gripped the nation’s capital is a habit of lurching from one crisis to the next rather than taking time to do a bottom-up assessment of the effectiveness of current policy.

The Bush tax cuts are a great example of this. Republicans want to extend all of the Bush tax cuts, while Democrats generally support extending the tax cuts for only the bottom 98 percent of households. But few end up debating whether these tax cuts are actually optimal policy, and if perhaps a better replacement exists.

This is unfortunate, because the Bush tax cuts are pretty poor policy; in a decade of existence, they have accomplished none of the goals they were intended to achieve. In fact, judging the Bush tax cuts based on their economic impact, distributional impact, and cost, they have been an outright disaster.

Economic stagnation

Under practically any measure, the economy performed exceedingly poorly in the years following the Bush tax cuts. Of the 10 economic expansions since 1949, the economic expansion from 2001 to 2007 ranks last in GDP growth, investment, job creation, and employee compensation. Economic growth was actually 50 percent faster during the 1990s—a time of higher tax rates—than during the 2000s.

The Bush tax cuts are particularly poorly-designed for the current economic situation. Effective job creation policies are those that address the demand shortfall that continues to hold back full recovery. Yet the Bush tax cuts disproportionately go to taxpayers who simply save the money, trading public savings for private savings but doing little for the economy itself. This is why the Bush tax cuts for the rich cost about five times as much as extending the low-income tax credits, yet the job impact is about the same.

Rising inequality

The Bush tax cuts also contributed to rising income inequality in the economy. More than half of the tax cuts went to households who make more than $170,000, and almost 40 percent went to the top 1 percent of households (i.e. those making more than $450,000) for an average tax cut of nearly $100,000. The top 0.1 percent of earners (i.e. those making over $2.4 million) got an average tax cut of roughly $500,000, more than 450 times larger than the $1,100 received by the average middle-income family.

Cost

The Bush tax cuts have already added more than $3.4 trillion to the national debt, accounting for more than 40 percent of the total debt added since 2001 (and roughly 80 percent of the debt added during the Bush administration). In fact, the interest we paid on the Bush tax cuts debt in 2012 alone ($65 billion, or 1.9 percent of $3 trillion) exceeded the entire federal budget for nondefense research and development. And over the next 10 years, these tax cuts will add another $4.3 trillion to the debt, again accounting for nearly half of projected accumulated debt.

Solution

One possible replacement for the Bush tax cuts is a proposal we authored as part of the Peterson Solutions Initiative to consolidate work and family tax preferences for low-income taxpayers and extend them to the middle class. Largely based on past proposals from EPI (see Robert Cherry and Max Sawicky’s 2000 report, Giving Tax Credit where Credit is Due) and the Bipartisan Policy Center (See Debt Reduction Task Force Co-chairs Pete Domenici and Alice Rivlin’s 2010 report, Restoring America’s Future), this proposal would:

  1. Eliminate the personal exemption, standard deduction, Earned Income Tax Credit, and Child Tax Credit, and Child and Dependent Care Credit
  2. Implement a Work Credit at 30 percent on the first $20,300 earned per worker, with no phase-out and fully refundable
  3. Implement a Family Credit at $1,600 per child, with no phase-out and fully refundable

The proposal would accomplish four distinct goals. First, it would simplify the tax code for low-income taxpayers, making the tax code more user-friendly and transparent. Second, it would promote upward mobility for low-income households by reducing the high effective marginal rates that they face as their income rises and safety net programs phase out. Third, it would act as a replacement for the Bush tax cuts for these households by providing (on average) greater benefits to the bottom half of households. And finally, because it disproportionately benefits low– and middle-class households that tend to spend larger shares of their incomes, it would provide a much greater benefit to the economy than an extension of the Bush tax cuts would provide.

It should be noted that this isn’t the only option for the Bush tax cuts. My colleagues Josh Bivens and Andrew Fieldhouse have focused on the higher end Bush tax cuts, proposing to use half the revenue from their expiration for deficit reduction and half to finance powerful fiscal stimulus such as unemployment benefits, state and local budget relief, infrastructure, and a targeted tax rebate. This proposal would generate more than 2 million jobs in 2013 and reduce the 10-year deficit by $650 billion relative to current policy.

The bottom line is that the Bush tax cuts are costly and inefficient, and they don’t deserve to survive the year-end fiscal showdown. Their replacement should focus on job creation and supporting middle-class families. But given how awful the Bush tax cuts are as a matter of policy, it isn’t terribly difficult to find a worthy replacement.

Tagged

  • benleet

    Your wage supplement would affect 40% of all workers, but since they earn less than 2% of all personal income, it’s not a great mega-shift.

    40% of all US workers earn in wages less than $20,000, according to the annual Social Security Administration report Wage Statistics for 2011. See http://www.epi.org/publication/restore-full-employment-massive-infrastructure/

    Collectively the lower earning 40% of workers earn $198 billion which is 3.2% of all wage income which is also only 1.6% of all personal income, about. Your proposal would give a 30% raise, as much as $6,000 to the first $20,300, and if married with 2 incomes at $20,000 and 2 children, the couple could boost their joint income by $15,200 — a $40,000 wage income could increase to $55,200, theoretically. Hmmmmmmm. The scholars at PERI (UMass/Amherst) have a plan to raise the minimum wage by 70% to $12.30 an hour and increase the EITC by double. The EITC discriminates against unmarried workers, their refund is negligible, so your plan is an improvement on that score.

    What’s the average income for all 151 million workers? The average disposable income I calculate is $73,000 for all 151 million workers. That’s probably not a valid conclusion since no one else comes to that conclusion. $41,211 is the average wage income for 2011. But 44% of all taxpayers (155.9 million total taxpayers) report incomes of $40,000 or less, and that’s 11.6% of all taxable income according to the Joint Committee on Taxation, 2012.

    I do these calculations to convince myself of the need to raise incomes at the lower end, a demand-led growth strategy, that should be the national priority, in my opinion.