Does the Bush Tax Cut Deal Make Smart Budget Reform More Likely?

The Bush tax cut deal is law. That means the next two years mark a unique moment in US history where tax rates on income and investment are both historically low and historically temporary.

You know the saying, "If you don't like the weather, wait a minute"? Well, if you don't like this tax law, wait a year.

For months, we've debated the arguments for and against extending the Bush tax cuts. Now that they're extended, there are two important questions to ask: Is this smart short-term policy, and does this make smart long-term policy more likely?

The economic community is split on whether this is smart short-term policy -- at least, compared the likely alternatives. The economists and economic writers I trust most appear convinced that the compromise is a poor stimulus that will do little to lift economic growth. On the other hand, economic forecasts from Moody's and New York investment banks expect the deal to lower employment and boost growth by about half a percentage point, each.

Does the deal make smart long-term policy -- that is, smart, pro-growth deficit reduction -- more or less likely? You can see it both ways. On the one hand, kicking the can down the road sounds like convenience rather than prudence. On the other hand, consider that this deal will add hundreds of billions of dollars to the 2011 deficit. With higher debt and higher growth, U.S. investors might demand higher medium-term interest rates, making it more expensive for both the government and private sector to borrow money. This would embolden the deficit hawks to demand the president do something to show lenders that we're serious about getting spending and taxing back in line.

But how we balance spending and taxing is crucial. If we start slashing the non-security discretionary budget in 2011 to please the bond vigilantes, we could hurt the recovery, Paul Krugman argues today. If we announce a dramatic tax increase that exclusively hits the top percent, conservatives respond, we'll scare businesses just at the moment we're trying to nudge them into hiring.

If you want to know what Obama might do next, look at what he just did. He gave Republicans what they wanted -- lower taxes for the rich -- and asked for something big in return -- more middle class tax cuts, more money for energy firms, and a year of unemployment benefits. If he follows this template in the next year, expect similar concessions (to discretionary spending or even Social Security) in exchange for something big, like a new tax law that lowers rates, eliminates tax expenditures and ultimately skims more income from the wealthiest Americans into the government's coffers.

The next tax deal might not be as easy as the last one. By cutting taxes to their lowest rates in 40 years a dozen months before they hope to raise effective tax rates, the White House has moved the limbo pole dangerously close to the ground. Whether the administration finagles a new deal before 2012, or loses the White House in the process, will depend largely on whether the recovery makes the president look like a dope for giving Republicans their tax cuts, or a genius for keeping taxes low in the short-term while shaping a long-term plan to raise taxes, grow the economy, cut the deficit, and steal reelection it the process.