CBO: Tax-cut extensions would have negative impact in the long run

The official budget scorekeeper for Congress provided ammunition Tuesday to lawmakers who want to extend all the Bush tax cuts on a temporary basis.

Douglas Elmendorf, director of the Congressional Budget Office (CBO), said keeping the tax cuts in place would boost the economy in the short term but have a negative impact as time goes on. 

A study by the CBO found that all of the tax-extension plans being considered in Congress would increase the gross national product, which measures the size of the economy plus income from U.S. assets abroad. 

But the CBO also found that extending the tax cuts, which are scheduled to expire at year’s end, would add to the debt and reduce income in the U.S.

Lawmakers are debating whether the Bush-era tax rates should be extended on a permanent or temporary basis. President Obama wants the tax cuts for the middle class — defined as individuals making less than $200,000 and families making less than $250,000 — to be made permanent, but Republicans and some Democrats also want to keep the breaks in place for upper-income taxpayers.

Elmendorf said that making all or some of the tax cuts permanent would provide a bigger boost to income and employment in the next two years than a two-year temporary extension. He also said that extension of tax cuts for all incomes would provide a bigger boost than an extension of only the cuts for the middle class.

The extensions “would raise output, income and employment during the next two years, relative to what would occur under current law,” Elmendorf told the Senate Budget Committee, according to prepared remarks.

But CBO’s estimates also found that all the options under consideration “would probably reduce income relative to what would occur under current law.” The permanent extension would reduce income by 2020 more than a temporary extension, and a full extension would have a bigger negative impact than the partial extension, the budget office found.

That impact would get only get bigger in future years.

“Beyond 2020, and again relative to what would occur under current law, the reductions in income from all four of the policy options would become larger,” Elmendorf said. “Either a full or a partial extension of the tax cuts through 2012 would reduce income by much less than would a full or partial permanent extension.”

Elmendorf cautioned that other measures to boost the economy, including more government spending, would have a similar effect — they would help in the short term but hurt in the long run because they would add to the debt.

But he noted that an extension of the Bush-era tax cuts is not the most cost-effective way to stimulate the economy.

“Compared with the options examined here for extending the expiring tax cuts, various other options for temporarily reducing taxes or increasing government spending would provide a bigger boost to the economy per dollar of cost to the federal government,” Elmendorf said.

CBO, like other forecasters, expects a tepid economic recovery and large federal budget deficits over the next few years. The CBO expects that the unemployment rate, now at 9.5 percent, will remain above 8 percent until 2012 and above 6 percent until 2014. 

The deficit for this fiscal year, which ends Thursday, will exceed $1.3 trillion, which will be about 9 percent of GDP. That's slightly down from last year's shortfall, which was 9.9 percent of GDP, but still among the highest deficit levels in 50 years.

Senate Budget Committee Chairman Kent Conrad (D-N.D.) on Tuesday questioned the wisdom of extending all of the tax cuts permanently.

“For many people, it is counterintuitive that tax cuts could hurt economic growth,” Conrad said.

Conrad, who has backed a temporary two-year extension of all the tax cuts, seized on CBO’s finding that the tax cuts over the long term would grow debt and “serve as a weight around the neck of the economic engine of our economy.”

Conrad said he and other economic experts, including Fed Chairman Ben Bernanke, want to put a plan in place that would refrain from fiscal austerity measures while the economy is still struggling but start cutting deficits once it has recovered.

Sen. Judd Gregg (N.H.), the top Republican on the Budget Committee, said the focus shouldn’t be on the Bush tax cuts but on spending, which is a long-term debt problem. Gregg pointed to CBO data that showed the level of government spending would increase under Obama administration policies over the next decade.

“Dealing with reality, the [size of] government is going to go from 20 percent to 24 percent of GDP,” Gregg said. “That spending is the driver, in large part, of the gap that's going bankrupt.”

Elmendorf told Gregg that spending at that level would be higher than the historical average. Major factors in that growth will be the aging population and federal spending on healthcare, Elmendorf said.