What Happens If All The Bush Tax Cuts Expire?

Here's why nobody in Washington will allow the Bush Tax Cuts to expire.

Based on this from Brad Plumer, and the chart he got from Jonathan Bernstein, it wouldn’t be pretty:

What will the economy look like in 2013? A great deal depends on what Congress decides to do at the end of this year. Remember, the Bush tax cuts are expiring, the payroll tax holiday will sunset, and a bunch of new spending cuts under the debt-deal “sequester” are scheduled to kick in. Coming all at once, that’s a potentially big drag on growth.

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To put this in perspective, the Federal Reserve expects the economy to grow at a roughly 2.9 percent pace in 2013. If Congress does nothing at the end of this year, much of that growth could be wiped out, and there’s a strong possibility that the United States could lurch back into recession. (Granted, a lot could depend on how the Fed reacts in this situation.)

On the flip side, as Ezra discussed in Thursday’s Wonkbook, letting all of the tax cuts expire and spending cuts kick in would also cut the U.S. deficit considerably: “Public debt falls from 75.8 percent in 2013 to 61.3 percent in 2022.”

Given the fact that we’ve already seen evidence that the 2.5% growth forecast for this year may turn out to be overly optimistic, we probably put to much stock in the 2.9% forecast for 2013. If growth (not factoring in the impact of the changes coming on December 31) is less that 2.9%, then the impact of what Plumer calls “Taxmageddon” will be even worse.

In many ways, this is the same dilemma that the Obama Administration and the lame duck Congress faced in December 2010 when the cuts were scheduled to expire for the first time. The economy was growing then too, and beginning to recover from the Great Recession, but growth was slow and job growth was anemic at best. Allowing tax rates to rise in January 2011 as the law would have allowed would have sucked billions of dollars out of the economy just when the economy was trying to recover. As we saw, the opening months of 2011 were slow-growth to begin with, had the tax cuts not been extended it’s entirely possible that we would have been pushed into another recession. At the very least, we would have seen slow growth and the job market would have taken even longer to recover. Today’s 8.1% unemployment rate very well could have been closer to 9% under those circumstances. The same goes with the decision to extend the payroll tax holiday. It was, in part, because of the fear of what would happen to the economy that President Obama ended up agreeing to extend all the tax cuts, and it was probably the right decision at the time even though it did involve breaking a campaign promise and setting up a pattern of giving in to GOP demands that would go on to make future negotiations more difficult.

When November and December 2012 roll around, the President and Congress will be faced with the same dilemma. Quite honestly, I don’t believe that allowing the tax cuts to expire is going to be considered a serious position on either side of the aisle, not under current economic conditions. As was the case in 2010, the big point of contention will be what happens to the tax rates for those making more than roughly $200,000 per year. My guess is that what happens there will depend greatly on what happens in the November election but that if the GOP really wants to push the point they will be able to once again get the President to agree to a full extension rather than a limited one. In the end, it’s a game of chicken and when both sides already know that neither one wants to allow the tax cuts (or the payroll tax holiday) to expire because of the impact it would have on the economy, that gives the GOP a significant negotiating advantage. So, count on the Bush Tax Cuts staying around for at least another two years absent some kind of comprehensive tax reform in the first year in of office whoever happens to take the oath of office on January 20, 2013. At that point, shouldn’t we start calling them the Obama Tax Cuts, or maybe the Romney Tax Cuts?

FILED UNDER: Barack Obama, Campaign 2012, Economics and Business, Politicians, Taxes, US Politics
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. al-Ameda says:

    I’ve always thought that Obama was gambling that eventually the growth rate would move toward 4% and that would start to take the deficit down.

    In a weak economy it is generally not sound policy to increase taxes. Austerity policies do not foster economic growth. You cannot generate economic growth by reducing aggregate demand.

  2. André Kenji de Sousa says:

    While we are discussing that, the Debt to GDP ratio is going to more than 100%. When that´s going to explode that´s not going to be pretty(Let´s remember that Italy was always pointed out as a example that having very high debt to GDP ratio was not a problem).

  3. Cycloptichorn says:

    They should let them expire anyway. I think this is just an extension of the one-way tax ratchet argument: raising taxes ALWAYS lowers GDP, so it’s NEVER a good idea to do so.

    Except, sometimes, it is a good idea to do so. I would trade slightly lower GDP for a few years for not having massive deficits for, oh, the rest of my life.

  4. Hey Norm says:

    Trying to figure out why you left this part out…

    “…The stimulus is finally winding down and overall government spending is expected to shrink next year (pdf), thanks to tighter budgets. There’s a baseline austerity built into the budget that will subtract roughly 1 percentage point of GDP growth next year, even if Congress extends all the Bush tax cuts and avoids the sequester….By contrast, during Ronald Reagan’s first term, when the economy was hauling itself out of the 1982 recession, federal and state governments were expanding and helping to boost GDP growth. Now, the opposite’s happening. As Jared Bernstein puts it, “We’re actively applying leeches.” The only real question is how big the leeches are going to be…”

    Guess it didn’t fit your small government ideology.

  5. legion says:

    @al-Ameda:

    You cannot generate economic growth by reducing aggregate demand.

    Yes, but the Bush tax cuts didn’t affect AD; they were largely targeted to very high-income earners; the main impact of letting them expire would be to increase the marginal rate on top earners, while providing a significant boost to gov’t revenue. There is significant economic evidence that increasing that high-earner marginal rate does actually improve the economy, since those high-earners (the so-called “job creators”) aren’t actually very efficient at getting their vast wealth cycled back through the economy & encouraging growth and wealth creation in other areas.

  6. JohnMcC says:

    Back during the previous hullabaloo over the expiration of the Bush tax cuts I found this illuminating web-graphic. It turns out to still be available.

    http://cooklaw.co/blog/the-bush-tax-cuts-what-to-do.

  7. al-Ameda says:

    @Hey Norm:

    The stimulus is finally winding down and overall government spending is expected to shrink next year (pdf), thanks to tighter budgets. There’s a baseline austerity built into the budget that will subtract roughly 1 percentage point of GDP growth next year, even if Congress extends all the Bush tax cuts and avoids the sequester

    That is exactly why the Republican prescription of austerity-based budget cutting should concern everyone who wants to avoid a double-dip second recession. The public sector has been shedding jobs since 2008, and is the primary reason why economic growth and job growth has been anemic.

  8. Moosebreath says:

    Hmm — funny that Doug never makes this argument over the other side of the austerity coin of cutting government spending during a recession. Nope, it’s only that taxes cannot be raised on the 1%.

  9. PJ says:

    @Moosebreath:

    Nope, it’s only that taxes cannot be raised on the 1%.

    The 1% are the job creators.
    Especially when they take all their assets, renounce their citizenship, and move somewhere else.

  10. Stan says:

    I’d like to see a similar graph showing what happens if the Bush tax cuts are left in place and the Ryan budget plan is enacted.

  11. While there’s certainly a relationship between taxation and the economy, it’s not where near as precise as this chart suggests. Making the argument that increasing taxes in January will slow economic growth is fine, but to suggest we have any idea how much is ridiculous.

  12. Murray says:

    Sure, if we go back to the 1990s tax rates the economy will completely collapse.

  13. Scott @ Engage America says:

    We have a total debt over $15 Trillion and projections that by 2021 federal debt will be over $20 trillion (http://1.usa.gov/wt4DPi). We need to reduce the deficit, but not at the expense of our economy. We cannot tax ourselves out of this problem. We need to cut spending.

  14. Gold Star for Robot Boy says:

    @Scott @ Engage America: Then let’s end the War on Drugs, cut defense spending by one-third and kill foreign aid to Israel. You in?

  15. Tsar Nicholas says:

    Good blog post. A+ work.

  16. Tsar Nicholas says:

    @Gold Star for Robot Boy: You’re not cutting and pasting George Soros or some Ward Churchill-style nutbag on a college campus, are you?

    In any event, the drug war indeed should be ended at the federal level. Except of course directly in connection with ports and borders. Personally speaking, I think pot should be legalized, both for medicinal and recreational purposes. But if State X wants to spend its own state tax dollars waging a drug war that certainly should be its local prerogative.

    Cutting defense spending by a third seems a bit much. We are in the middle of two wars, you know? I would cut DOD by about a quarter.

    Cutting aid to Israel would be one of the dumber ideas in the history of dumb ideas. You don’t pull out the rug from key allies. Even the loopiest of liberal Democrats in Congress fully understand that. South Korea and Taiwan fall into that same category. To the extent foreign aid should be cut, and no doubt it should, you put countries like Egypt on the prospective chopping block and you make them justify the expenditures. The same holds true for the PA. Friends are frenemies must be treated differently. In politics as well as in life.

  17. steve says:

    Doug Mataconis is a Keynesian. Who knew?

    Steve

  18. grumpy realist says:

    @Tsar Nicholas: If we took some of that defense $ and put it towards R&D, chances are that we would have something much better down the road.

    I thought we got out of Iraq?! What’s the second war?

    (Me, I’m for legalizing everything that you can grow in your back yard, then hang up and dry. It’s the processing that causes all the problems. Plus will inspire a huge number of bootlegger gene-splicers, which must stimulate the economy for laboratory equipment. )

  19. sam says:

    @Stan:

    I’d like to see a similar graph showing what happens if the Bush tax cuts are left in place and the Ryan budget plan is enacted.

    I don’t think you could show such a thing on a family blog.

  20. rudderpedals says:

    Can anyone tell from this chart just how much of the everything expires curve is due to sequester?

  21. Ben Wolf says:

    @Murray:

    Sure, if we go back to the 1990s tax rates the economy will completely collapse.

    Raising taxes on top earners will have little to no macroeconomic effect, but the middle class simply cannot afford a tax hike. This is not a typical business-cycle recession: we’re mired in a debt-fueled boom/bust cycle as described by Hyman Minsky decades ago. The private sector, particularly households, is simply too heavily leveraged to maintain its current level of spending in the face of a tax increase. If anything taxes for the middle class and poor need to decrease so the deleveraging process can accelerate.

    Those who continue calling for spending cuts are ignorant of the reality deficits are giving the private sector a chance to catch its breath and get solidly back on its feet.

  22. André Kenji de Sousa says:

    Austerity with tax cuts is a bizarre concept that only exists in the United States of America.

  23. Ron Beasley says:
  24. LC says:

    Let them all expire. It costs money to provide the services most people want. These cuts were a disgrace. A huge waste of a surplus to make the 1 percent richer and run two wars on credit. Bring back those 30 or 50 tax brackets so we have a fair and progressive tax system. And get rid of different rates for different kinds of income.

  25. ab says:

    @Ben Wolf
    How do you decrease zero? The “poor” don’t pay taxes, they get substantial refunds and hand outs. The term “fair and progressive” is an oxymoron. Fair would be everyone paying the same percentage. A question for those who want to increase another’s taxes, do you take any deductions? Put YOUR money where YOUR mouth is. I’d rather give my support in money and time to local non-profit and non-government groups to help the less fortunate.

  26. matt says:

    @ab: The poor pay taxes on a daily basis so you really should drop that terrible talking point. Your ignorance is inexcusable when you have the power of the internet at your fingers..

  27. The economy around here has come to a stand still almost, talking with vender from around the country the talks the same. what gives my friend . any news from the hill on what and where we are going . I have 17 people working for me and we have been have a tough time the last 3 years. it realy start great out of the gate this year, and now i think is worst than 08
    No silver lining here