Extend the Bush Tax Cuts ... Then Kill Them?

If Congress fails to act, the Bush tax cuts will expire at the end of 2010, and Americans will face a tax increase worth several trillions of dollars over the next ten years. Make no mistake: Congress will do something. But what?

President Obama has promised for years that he will extend the tax cuts, except for families making more than $250,000 a year. Republicans like Sen. Jon Kyl and Rep. Eric Cantor have responded: over our dead bodies. This fall should be interesting.

To think through our options on the tax cuts, I spoke with Roberton Williams from the Urban Institute. An edited transcript follows:

Republicans are getting righteous about extending the entire Bush tax cut. Why shouldn't we?

We have this weak economy, and a huge tax increase will have a huge negative effect. But we also have this deficit, and we need more revenue. So the obvious tradeoff is between the effects on the economy and the huge need for revenues to fill the deficit hole.

Is there a middle ground?

I see two option. One is extend the cuts for most people but not for the rich. This is Obama's idea. He argues that it's OK to raise these taxes, because the rich aren't hurting, they've saved up, and they're not going to cut back on their spending. Another side says they're the engines of growth in the economy, and we already hit the rich with health care, and tried again with carried interest. It's a deep well but it's not a bottomless well. You can't go there forever. In terms of research, the evidence is mixed.

Is there a compromise that doesn't hit the rich?

The other approach is extend everything in the short term, by one or two years. First, you avoid the dangerous tax increase. Second, Congress has so much to consider that they'll do a slapdash job on any new tax bill, anyway. They don't have time to sit back and reflect and think: you know, maybe we don't want to extend some things in our current system, maybe we should do different type of reform. The problem is that in two years, you have presidential elections. But if you put it off next year, you might buy time for the economy.

You agree with those who say we shouldn't raise any taxes for 2011?

I think we could extend the whole thing by a year, or two years. But the position that says "no tax increases ever, over my dead body" strikes me as one of the most irresponsible campaign promises you can make. Quick example: what if we have to fight a war? Where are you going to get that money? You should never say never.

So what do you think are the most likely outcomes from the Bush tax cut debate this fall?

The compromise that people could agree on is the short-term extension, because that gets you out of the bind this year. A little bit harder would be the Obama proposal because you're going to have all the Republicans and some of the Democrats against raising taxes, and nobody wants to be the guy who kills the economy.

Allowing the whole thing to expire is the least likely option. It's also the worst outcome we could have. Permanent extension of the entire act is number two least likely. I think there's a big enough block that recognizes the fiscal reality of our structural deficit.

Could the most likely scenario -- a short-term extension -- turn out to be a good idea in terms of policy?

It's consistent with the bipartisan commission on the deficit. They're saying we want to get things started in two or three years down the road, not right now. You don't want any of the depressing aspects of higher taxes.

But the biggest problem with extending anything in the short term is it becomes an extender, and next year we'll face the same question. Then maybe we extend them again. How do you keep things that we extend every few months from becoming permanent?