'The Long-Term Budget Problem Is 100 Percent Spending'

Republicans have been called hypocrites and worse for supporting the Bush tax cuts, which come up for renewal at the end of the year. Some deficit groups project that, if extended, they could add up to $3 trillion to our deficit. I've repeatedly called the tax cuts unjustifiable in the long run, and I've called for tax increases in the next few years to repair the budget.

But I'm wrong. Well, plenty of people think of wrong, including Brian Riedl, a research fellow with the Heritage Foundation who recently wrote the WSJ article "The Bush Tax Cuts and the Deficit Myth." Yesterday we talked about the Bush tax cuts, the deficit, and big government spending. An edited transcript follows:

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Make the case for the Bush tax cuts. Why aren't they as bad as liberals and moderates say? Why should we strongly consider extending them forever?

There are a lot of myths about the Bush tax cuts and the deficit. The first myth is that it caused the deficit. Going by CBO numbers, you take the $5.6 trillion surplus that was projected in 2001 and look at where we are today, and the tax cuts are responsible for only 14% of the swing. Everything else was the result of huge new spending and two recessions.

The second myth is that even if we extend all the tax cuts and fix the Alternative Minimum Tax, revenues will still exceed the historical average of 18 percent by 2020. The deficits projected by 2020 are because of spending. Let me say that again: the long term budget problem is 100% a problem of spending. There is no long-term revenue decline.

That leaves a lot of heavy lifting on the spending side. How do you close the gap?

First, when you're in a hole stop digging. Repeal ObamaCare, repeal the stimulus, repeal TARP.

Repeal the Recovery Act ... does that mean you were against the stimulus tax cuts as well?

I think Making Work Pay [that's the Recovery Act's tax cut plan, which gave families tax rebates up to $800] has had no positive effects. Making Work Pay was just a tax credit. Tax rebates never work because they don't change behavior. On the other hand, if you cut marginal tax rates, you create productivity, which causes growth.

How about long term?

I would create one cap for the whole budget. Government shouldn't grow faster than income. Under the cap, you can do what you want. But the federal budget as a whole should not grow faster than the family budget. That includes Social Security, Medicare and Medicaid reform.

How do you fix Social Security?

For Social Security, there are only three levers: means testing, raising the retirement age, and raising taxes. Raising taxes is the worst way. The reasonable way to fix Social Security is to raise the eligibility age combined with modest means testing of benefits at the top. If you do that you can pretty much fix it right there without new taxes.

How about Medicare?

Nobody has the answer, but I'll give it a shot. First, remember that payroll tax only funds Medicare A. The rest is funded by 25% premiums and 75% general taxes. Why should we pay for Warren Buffett's medicine? We shouldn't. So let's have heavier means-testing at the top, which could shave trillions off our long-term liability.

In the long run you want to fix the whole system system by making it more like the federal health plan. There, you're given an amount to purchase your own health care and there are 13 private plans competing for customers. Rep. Paul Ryan has proposed converting Medicare into something like that. Simplify the system, and bring in choice and competition.

The way I see it, the government has a revenue-spending gap, and I think we should close it from both sides. That means reforming entitlement programs but also raising taxes. Why not raise tax rates on the top five, one, 0.1 percent of the country back to their 1990s levels?

It would have a negative effect on the economy. We tax tobacco because we want less of it. If you're going to tax working, saving, and investing, you'll get less of it, and the economy will grow slower. The top five and one percent: a lot of them are small businesses.

But we raised tax rates twice in the early 1990s. The top income rate went from 28 percent to 40 percent, and then we had a historic economic boom. It was a larger boom than the 1980s expansion after the top rate fell from 70 to 28. Is it really so clear that raising tax rates will hurt the economy?

Putting it all together like that is a little crude. First, you're counting a deep recession in the early 1980s. Second, it wasn't until 1986 when the rate fell below 50%, and the economy grew more slowly in the early part of the decade. Once those tax rates were in place the economy grew very fast. Also, we had tax rate increases in 1990 and 1093, and the economy grew sluggishly until 1995 and 1996. What happened there? You had a Republican Congress causing gridlock, you had NAFTA, and you had a capital gains rate cut. Suddenly, growth jumped and the stock market jumped.

My point isn't that there's an optimal top rate, or that tax rates don't matter. It's that growth occurred in the 1990s with the top tax rate at 39.6 percent. Today the top rate is 35 percent. But clearly the economy can clearly grow with a higher income tax rate.

Yes, the economy can grow with a 39.6 tax bracket.

Last question. Like the 1990s, the 2000s had a recession and long jobless recovery ... but this time, we muddled along after tax cuts. Why cut Bush slack?

The reason we grew more slowly out of the 1993 recession was partly because tax rates prevented the rebound a little bit. The 2000 recession was a different recession. The stock market crash precipitated it. In any recession that starts in the stock market, the bomb goes off in the business sector and hiring will be slow. That's actually one reason to cut Obama slack.

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The Bush tax cuts of 2001 were not necessarily the most pro-growth. The 2003 tax cuts were. They cut marginal rates and investment taxes. In the 18 months before the late May 2003 tax cuts, 1 million net jobs were lost. In the following 18 months, 2.3 million net jobs were gained. I'll pass along a chart I made with figures for the six months before and after the 2003 tax cuts [It's to the right. Read the full PDF here]. Again, rebates don't create growth. Cutting rates create incentives for productivity and prosperity.