Feldstein: Extend the Bush Tax Cuts—For Now

Martin Feldstein says we shouldn't allow Bush tax cuts to expire for high income households as the administration is proposing, we should keep them in place for another two years:

Extend the Bush Tax Cuts—For Now, by Martin Feldstein, Commentary, WSJ: This is not the time for a tax increase. But unless Congress acts, under current law the existing income tax rates will rise sharply at the beginning of next year. Congress should vote now to extend all of the current tax rates for two years, including the tax rates on dividends, interest and capital gains. Limiting the resulting tax-rate cuts to two years would reduce the projected future fiscal deficits. The sooner Congress acts, the stronger our prospects for continued economic recovery.

A tax increase next year could easily derail the current fragile expansion. ... A 2011 tax increase that reduces economic incentives and household spending would raise the risk of a new economic downturn.

President Obama proposes to increase tax rates on high-income households while making the existing tax rates permanent for taxpayers below the top tax brackets. While the increase would hit only a relatively small fraction of all households, that group represents a large share of total taxes and of private spending. Raising their tax rates would be a substantial blow to overall spending and therefore to GDP growth. ...

Although it is important to avoid increasing the current tax rates until the recovery is well established, the enormous budget deficits that are now projected for the rest of the decade must not be allowed to persist. ...

It would be wrong therefore to commit to the permanent reduction in tax rates for all taxpayers below the top brackets that is called for in the Obama budget. ...

Such a limit on the future tax cuts should be combined with policies to slow the growth of spending. ... If Congress cares about future deficits, it will prevent that unprecedented rise in government spending. It will also do more to deal with the spending programs that are hidden in the tax law like the health-insurance subsidy, the child-care credits, and the deductibility of local property taxes.

Failure to cut future deficits would mean a weaker recovery and slower long-term growth. ...

The fragility of the economic recovery means that it would be dangerous to allow any taxes to rise in 2011. The inherent uncertainty about the out-year deficits means that it would be unwise to enact tax cuts that stretch beyond the next two years. Congress should move quickly to reassure taxpayers and financial markets that the current tax rates will be preserved for two years but that further tax cuts will depend on the future fiscal outlook.

We could always shift the tax burden, i.e. allow the tax cuts to expire at the upper end of the distribution and replace them with cuts at the lower end (for the two year period or even beyond). That would make the overall distribution of taxes more progressive, something that's needed, and it would get money into the hands of people who need it. Shifting the tax cuts to people who are more likely to spend the extra money rather than put it into savings would provide an even larger boost to the economy.

It's also worth noting that if the worry is about the effect on the economy and the deficit, it would also be possible to allow the tax cuts to expire and then replace the missing demand with additional temporary government spending, say for two years. Since the spending is temporary -- it only lasts for two years just like the tax cuts -- the long-run impact on the deficit would be the similar. The point isn't that we should do this, or that we shouldn't, it's that there's no necessity in keeping the tax cuts in place at the upper end of the distribution to preserve aggregate demand. A tax increase can always be offset by tax cuts in other places or by additional government spending. One argument is that any policy that involves increasing taxes on the wealthy is inherently inefficient, e.g. that it lowers productivity, but I don't find the empirical evidence for that argument to be very compelling (and even if some categories of taxes are inefficient, that doesn't meant that, say, a capital gains tax can't be replaced with some other type of tax with more desirable properties).