Bush Tax Cuts, Act II

Aug 7th, 2010 | By businessnews | Category: Business


Most economists agree there’s little choice but to end tax cuts from George W. Bush’s era. That means the fiscal war in Washington is only going to get uglier

By
Peter Coy

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Jonathan Ernst/Reuters/Corbis

You won’t find a truer believer in the big tax cuts of the George W. Bush era than Glenn Hubbard, the lanky, 51-year-old economist who is dean of Columbia Business School. The Republican academic was instrumental in designing the tax cuts, first as a Bush campaign insider and then as the President’s first chief economic adviser. The idea behind the cuts, enacted in 2001 and 2003, was to encourage work, savings, and investment, thus stimulating long-term economic growth. Hubbard is especially proud of the 2003 cut in taxes on dividends and capital gains, which he calls “the most pro-growth tax reform that anybody did since Kennedy.”

Now that the Bush tax cuts are coming up for renewal—they expire on Dec. 31 unless Congress acts—Hubbard has a queasy feeling about them. The cuts, he says, have been undermined by years of deficits. Until the trajectory of spending changes, he says, “deficits are just future taxes. You’re just talking about taxes today vs. taxes tomorrow.”

Precisely. The debate over extension of the Bush tax cuts is the opening salvo of a generation-defining fight. With Medicare and Social Security spending set to balloon as baby boomers retire and grow old, the terms of the conflict are crystallizing: What do Americans expect from their government? How much are they entitled to, how much are they willing to contribute—and what are they willing to do without?

Some people who once championed tax cuts unconditionally have a new catchphrase—or more precisely an old one that’s been repurposed: There’s no free lunch. Former Federal Reserve Chairman Alan Greenspan, an influential voice in favor of the first Bush tax cut in 2001, told NBC’s Meet the Press on Aug. 1 that extending the cuts without making offsetting spending reductions could prove “disastrous.” Said Greenspan: “I’m very much in favor of tax cuts, but not with borrowed money.”

The Bush tax cuts were the product of a rare confluence of political and economic forces we may never see again. They were premised on a sturdy principle: People, both as workers and as investors, respond logically to the incentives that government sets for them. The Economic Growth and Tax Relief Reconciliation Act of 2001 lowered the highest income tax rate (on individuals earning above $200,000 and households above $250,000) from 39.6 percent to 35 percent by 2006 and cut lower brackets’ rates by similar amounts—encouraging people to work more by letting them keep more of the fruits of their labor. The 2003 package accelerated the cuts and added the reductions in capital gains and dividends that Hubbard is so proud of because they reward people for saving and investing.

How did the cuts work? The long-planned 2001 tax reduction took effect during the mild 2001 recession and probably helped make it milder, says Joel Slemrod, founding director of the Office of Tax Policy Research at the University of Michigan’s Ross School of Business. But the cuts weren’t designed as Keynesian energy shots. They were supposed to promote long-term growth by realigning incentives. On that score their legacy is hard to measure because there’s no way to know how the economy would have fared without them. Many companies instituted dividends to take advantage of the tax break, but whether that induced more investment is unclear. What’s indisputable is that deficits grew while the U.S. economy rumbled along in slow gear: Growth averaged 2.3 percent a year from the end of the 2001 recession through December 2007, at which point the economy tumbled into the worst downturn since the Great Depression.

Today, high unemployment is coloring the debate over whether to extend the tax cuts. Democrats who originally opposed them on grounds that they favored the rich are open to continuing them now, figuring that the economy needs all the help it can get. Macroeconomic Advisers, a St. Louis-based economic consulting firm, estimates that a “full sunset” of the Bush tax cuts (and President Barack Obama’s modest middle-class tax cut of 2009), as called for by current law, would cut 0.9 percentage points off the growth in gross domestic product next year—a big hit considering that economists surveyed by Bloomberg News expect growth of only 2.9 percent next year.

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