To Avoid Fiscal Cliff, Let Bush Tax Cuts Expire

To balance the federal budget and avoid the fiscal cliff, we need to let the Bush tax cuts expire.

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The smart approach to addressing the "fiscal cliff"—the tax and spending changes scheduled to occur at year-end that would cut budget deficits sharply over time, but likely throw the economy into recession next year—is to replace it with a more fiscally and economically appropriate package. Specifically, we should let all the Bush-era tax cuts expire, scrap the automatic spending cuts ("sequestration"), and replace them with a balanced package that raises revenue and cuts spending over the long term while providing more deficit-financed stimulus over the next year or so to boost the weak recovery.

Policymakers face lots of hurdles to crafting such a "grand bargain." Here's one that they should immediately set aside: the belief that the stimulus measures they enacted to combat the Great Recession were ineffective, are a major source of our deficit problem, and therefore shouldn't be tried again. Nothing could be further from the truth.

[See a collection of political cartoons on the budget and deficit.]

In an earlier post, I explained that stimulus worked because, without it, the recovery from the recession would have been weaker, with higher unemployment. Moreover, it worked without adding significantly to long-term deficits or debt. That's shown in an updated analysis in which my Center on Budget and Policy Priorities colleagues use Congressional Budget Office data to compute the projected budget deficit if current policies continue (i.e., if policymakers prevent most of the "fiscal cliff" changes to taxes and spending from taking effect).

As the chart below shows, deficits are projected to fall into the middle of the decade before starting to rise again. While the economic downturn and the measures that policymakers took to combat it (the blue areas in the chart) contribute significantly to current deficits, their effects are temporary. By the end of the decade, their effect is minimal (mainly the interest on the additional debt that they generated). By far the largest ongoing contributor to the deficits shown in the chart is the Bush-era tax cuts, if policymakers extend them permanently.

[See a collection of political cartoons on the economy.]

The next chart shows that debt held by the public (the sum of all past deficits minus surpluses) grew sharply relative to the size of the economy (gross domestic product or GDP) in the Great Recession and is projected to continue growing into the middle of this decade. Of the factors shown, the Bush-era tax cuts and war costs account for nearly half of the public debt in 2019; recovery measures and financial rescues account for a much smaller percentage.

[Read the U.S. News Debate: Should There Be More Quantitative Easing?]

In light of this analysis, how should policymakers approach the fiscal cliff? First, they should recognize that in its impact on the economy, it's a "slope," not a "cliff," and that, even if all those tax and spending changes take effect temporarily, policymakers still would have some time in early 2013 to work out a responsible long-term budget deal that reduces deficits in a way that does not wreck the recovery.

Second, to strengthen the economy in the short-term, they should look to enact cost-effective stimulus measures—ones that boost demand for goods and services in the short term without adding significantly to deficits and debt in the longer term. They should extend two prominent expiring provisions for another year—emergency federal unemployment insurance benefits and the payroll tax cut. Or, better still, they should enact unemployment insurance and a temporary income tax cut targeted on the low- and moderate-income households who are most likely to spend most of any additional income they receive. 

[Read the U.S. News Debate: Should the payroll tax cuts be extended?]

Third, to make progress on deficit reduction, they should let the upper-income Bush-era tax cuts expire permanently. That would reduce deficits by roughly $1 trillion over the next 10 years while having minimal impact on the recovery—those tax cuts have low stimulus "bang-for-the-budgetary-buck."

Crafting a more comprehensive grand bargain won't be easy, but steps like the ones described above would move us in the right direction.

  • Read Keith Hall: Two Surveys, Two Different Stories in Jobs Report
  • Read Steve Zelnak: The Fiscal Cliff Threatens Job Creation, Economic Recovery
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