Paying for Tax Cuts Is Hard To Do…So Should We Sabotage It Entirely?
July 3rd, 2008 . by economistmomNews flash from the Senate, courtesy of Richard Rubin of CQ:
Senate Minority Leader Mitch McConnell offered a new strategy Thursday for breaking a deadlock over a series of expired and expiring tax provisions, but Democrats didn’t appear to see it as any kind of breakthrough.
In a letter to Majority Leader Harry Reid, D-Nev., and House Speaker Nancy Pelosi, D-Calif., McConnell suggested that Congress could offset the cost of the extensions by reducing the increase for non-defense discretionary spending contained in the recently adopted budget (S Con Res 70).
That marks somewhat of a shift for Senate Republicans, who have blocked consideration of a House-passed tax bill (HR 6049), creating a stalemate that has frustrated businesses who are eager to see their favorite tax provisions continued.
Republicans had recently been insisting that extensions of expiring provisions should not be offset, because they contend that Congress should not have to pay for any policy that would keep current tax policies the same. House Democrats, particularly the conservative Blue Dog Coalition, have demanded offsets, to comply with the pay-as-you-go budget rule.
In his letter, McConnell, R-Ky., changed his conference’s approach slightly, arguing that offsets for extensions of existing tax policy were acceptable as long as they came from spending.
“If agreed to, extension of expiring tax relief, including extension of the AMT [alternative minimum tax] patch and expiring energy tax incentives, could be accomplished in a way that achieves your stated goal of being deficit neutral, but without the unstated and unwarranted result of increasing the size of the federal government,” he wrote.
I’m sure this offer isn’t going to go over very well. And funny how a tax increase used to pay for a tax cut is considered an increase in the size of government, but the tax cut (the “tax expenditure”) in the first place is not. As I’ve said many times here before, just because you finance a tax cut by increasing the deficit doesn’t mean it’s free and doesn’t mean it’s not shifting more of our economy’s resources into government- sponsored/subsidized activities.
On a related note, if complying with pay-go in enacting tax cuts is so hard to do (politically), should we just give up and make it a lot easier to pass fiscally irresponsible (deficit-financed) tax cuts? That’s what the Tax Policy Center’s Rudy Penner seems to advocate, in his recent post on the TaxVox blog. Rudy argues that the current practice of setting the CBO revenue baseline to reflect current tax law creates a bias that favors extending spending over extending tax cuts. Rudy says:
…a renewal of a temporary entitlement at current levels, such as food stamps, is not considered to be a spending increase, but a renewal of temporary tax relief is considered to be a tax cut. This has important consequences if the Congress is applying a pay-as-you-go rule (PAYGO) that requires that any tax “cut” or entitlement “increase” must be paid for with some other tax increase or entitlement cut. Reauthorizing agricultural subsidies at current levels does not have to be paid for whereas extending temporary relief from the alternative minimum tax does require raising another tax or cutting an entitlement.
But Rudy fails to point out that “renewal” and “temporary” as applied to the entitlement program vs. the tax cut have different meanings. The “renewal” of a “temporary” entitlement program is a “reauthorization” of an entitlement program already in law. How is reauthorization of an existing program different from enactment of a new program, in terms of the budget process? The permanent, multi-year costs of entitlement programs are scored and subject to budget rules at the time they are enacted. At the time of reauthorization, the “renewal” does not represent new spending, at least not under CBO scoring conventions. In contrast, when a tax bill is (intentionally) written to have tax cuts expire at a certain date before the end of a budget horizon, only the costs up to that expiration are scored. So “renewal” of expiring tax cuts involves costs that have not previously been counted. (”Temporary” regarding tax cuts is really more temporary, at least as officially measured, than “temporary” regarding entitlement programs.)
Rudy’s line of thinking leads him to this recommendation:
A more sensible approach would regard all temporary spending tax policies to be permanent. In addition to leveling the playing field, it would make the baseline a more accurate predictor of future spending and revenues, because almost all temporary tax and spending provisions are, in fact, routinely extended.
Although I certainly agree with Rudy that for policy analysis purposes, it’s more realistic to consider permanent versions of tax cuts as revealing the true cost of expiring tax provisions (and by the way, that’s why any good budget analyst loves Table 1-5 in CBO’s annual Budget and Economic Outlook), I disagree that it would be “sensible” to set the official revenue baseline to assume that expiring tax cuts are permanently extended, if in fact those tax cuts were not scored at their initial passage under the assumption that they would be permanent. Adopting a budget baseline that assumed permanent extension of expiring tax cuts would effectively exempt such temporary tax cuts from fiscal discipline, as the costs of extension would never have been scored and would not be subject to pay-go even at the time of renewal. Adopting such a revenue baseline would sabotage the pay-go rules regarding tax cuts.
I have written on this before in an earlier post on the issue of “revenue neutrality”–to explain that the official revenue baseline, although admittedly not a realistic view of revenue policy, is still highly relevant in terms of the budget process and fiscal discipline:
The revenue baseline that matters for legislative purposes and complying with the pay-as-you-go (PAY-GO) rules is not the revenue path that is most likely to occur (and Howard [Gleckman, of TaxVox] is right that either extreme [of letting all of the tax cuts expire or none of the tax cuts expire] is highly unlikely)–but the revenue path that would be achieved under current law. Current law says all of the 2001 and 2003 tax cuts expire after December 31, 2010. That means that for pay-go purposes, letting some of the tax cuts expire in order to “pay for” the tax cuts you want to extend (Obama’s general strategy) is not really paying for it at all. Such a strategy would not technically be a revenue-neutral or deficit-neutral one, but a revenue-losing, deficit-increasing, pay-go violating, one (albeit, less of one than if you’re not willing to let any of the tax cuts expire, a la McCain).
So obviously Rudy just wants to make life easier for the next President regarding the thorny issue of what to do about the Bush tax cuts. Now, if Rudy instead wants to advocate a budget rule that disallows the legislative sunsetting of tax cuts that are obviously meant to be permanent (although I’m not sure how easy that would be to identify), or otherwise gets those permanent costs considered and scored at the time of initial legislative consideration (i.e., to be more analogous to the way entitlement spending is treated), I’m with him.
There are many budget nerd reasons why using reductions in discretionary spending to pay for tax cuts, but my main problem with the McConnell proposal is the reliance on unspecified discretionary spending cuts for savings to avoid making the tough choices on tradeoffs that responsible budgeting requires. The suggestion that Senate Republicans would support reductions in discretionary spending of the magnitude McConnell suggested would have a little more credibility if it weren’t for the fact that more than half of the Senate Republican conference voted for an amendment to the recent supplemental appropriations bill that had $10 billion more discretionary spending than the President requested and House passed. Or if Senate Republicans hadn’t overwhelmingly voted for the appropriations bills under the budget that had $23 billion more than the President last year. In fact, a lot of the spending the Senate tried to add to the supplemental — with bipartisan support — was for programs that were cut in the final omnibus negotiated to stay within the administration’s top line.
The spending cuts McConnell suggest essentially reflect the discretionary spending proposals in the President’s budget. Perhaps Senator McConnell is suggesting we adopt all of the spending cuts in the President’s budget. But I suspect a vote on those details of the President’s budget wouldn’t get much support from either side of the aisle judging by the press releases, floor statements and other comments from Senators of both parties promising their constituents to protect this program or that activity the President proposed to cut.
Its easy to talk about cutting discretionary spending in the abstract than it is to come up with specifics to turn that into reality. But absent specifics you can’t have a meaningful discussion of tradeoffs that paygo — and responsible budgeting generally — is designed to encourage.
Well let me apologize in advance for not being able to remove my partisan hat.
The Bush tax cuts were not scored as permanent originally for a pretty simple reason. Not only would they probably not be able to be sold politically they would have made a mockery of Bush claims that his long term goal was to balance the budget. So the Republican leadership at the time simply made the assumption that they would still be in power in year ten and so could play unlimited games with the sunset clauses to mask the actual cost. Oops, now they have discovered the uncomfortable truth that elections have consequences.
What has to be most galling is that Democrats currently have perfect freedom to cherry pick. At the time I regarded the lowering of the bottom rate and the new child tax credit as being simply gimmicks designed to get political cover for the cuts in the top rates. And I still believe that, which doesn’t mean I would oppose the extension of these particular provisions while letting some others expire on a schedule that after all was set by the Republicans to start with.
The Republican Party in the years after 2001 simply committed one of the worst sins possible in public life, they started reading their own press clippings and transformed ‘Permanent Majority’ from a goal to a perceived established fact. It simply wasn’t supposed to happen this way so they took no precautions to buffer their total agenda against the possibility that Democrats could simply reverse their tax cuts by literally doing nothing. They can gnash their teeth and wail like banshees that Democrats are ‘passing the biggest tax increase’ since whenever, but the cold reality is that they set the rules as they are at a time when that seemed the easiest way to sell their program. And there will be no vote to point at, except of course the one that extends the most popular cuts, and increases the estate tax exemption to a point where it removes any tax liability from the middle class. (And good luck voting against that package on the basis it doesn’t include big tax cuts for the ultra-wealthy. Americans may on the whole be a little selfish ‘wow $300!!’ but I don’t think they are stupid enough to turn down a continuation of the 10% rate because some gazillionaire ends up having to pay 39% on his marginal dollars.)
Oh well that is what happens when you consciously set out to game the system.
At the time I regarded the lowering of the bottom rate and the new child tax credit as being simply gimmicks designed to get political cover for the cuts in the top rates.
I agree. By lowering the lower end of the 15% bracket to 10%, Bush could claim that the largest percentage tax cut went to the lowest-wage tax payers. But, as can be seen in the graphs on this page, the smallest marginal tax cut went to those at the upper end of the 15% bracket. They received no marginal tax cut at all! They only got the $300 from the new 10% bracket.
Regarding the new child tax credit, Bush may have truly believed that it was justified. However, the new child tax credit (or the removal of the so-called marriage benefit) should not have been included in calculating the equity of the tax cut across different income groups. But it was used in a set of cherry-picked example released by the Treasury Department. You can read more on this at this link.