Should we let President Bush's tax breaks expire

Bush Tax Cuts

We should let the Bush tax cuts expire for the top income earners, but retain the remainder of the Bush tax cuts. There are two distinct economic factors that must be considered in this argument -- economic growth and the budget deficit (Krugman, 2010). For the former, the retention of the majority of the tax cuts is critical but for the latter, the tax cuts for the highest income earners must be allowed to expire.

In the current slow-growth economic climate, all measures possible must be undertaken to stimulate demand in the economy. America's companies face overcapacity, which has essentially neutered the ability of monetary policy to restore economic growth. Money is cheap and plentiful thanks to the Fed, but there are few takers because of overcapacity in industry. Under these conditions, economic growth can only be restored by spurring demand. If the tax cuts expire for the majority of Americans, that will lead to a decrease in demand because consumers will have fewer of their earned dollars to spend. The current state of the economic recovery is "too fragile to allow taxes to go up for the 97% of taxpayers not in the top bracket" (Isidore, 2010). While economist opinion is divided about the tax cuts for the top 3% of earners, there is consensus that the tax cuts must be extended for the lower 97% of earners in order to avoid a contraction in aggregate demand.

The budget deficit, however, is also a concern. The Bush tax cuts represent a decrease in government income, and this decrease was not met with any decreases in government spending. Former Fed chairman Alan Greenspan and former Reagan economic advisor David Stockman have argued for higher taxes as a means of helping to balance the budget. "You have to pay your bills," Stockman argued (Haris, 2010). In order to combat the budget deficit, there is a proposal that the tax cuts be extended except for those to Americans in the highest tax bracket. This approach would allow the government to collect $700 billion in revenue from high income earners that it would otherwise not collect if the tax cuts are extended in their entirety (Ibid).

This position is advocated by most Democrats and many leading economists as well. It is taken as established reality that the U.S. needs to address its permanent budget shortfall, and this means both decreasing government spending and increasing revenues. Letting the high end tax cuts expire would increase government revenue in the short run. This would contribute to overall budget health (Haris, 2010).

Another proposal calls for allowing the tax cuts to continue on a temporary basis. As Krugman (2010) points out, this contradicts established economic knowledge from Milton Friedman, who argued that transitory tax cuts are likely to be saved rather than spent, so that the wealthy would not use their windfall to help stimulate demand in the economy. Thus, there is little economic case for not allowing the tax cuts to the highest tax bracket to expire.

Each argument presented is predicated on the idea that the budget deficit is a critical problem that must be addressed, and that the tax cuts are critical element of addressing the deficit. Long-term interest rates on U.S. Treasuries are below 5%, indicating that there is little concern in the markets about the creditworthiness of the U.S. government -- deficits are not worrying the markets, only the politicians. This would imply that it is economically safe to allow all of the tax cuts to continue. Even though there are other causes of deficit -- bailouts and wars in particular -- and other means of addressing the long-run deficit such as health care reform, the Bush tax cuts still accounted for 25% of this year's deficit (Gale, 2010). As such, not extended the tax cuts can have a significant impact on the deficit, in particular when combined with measures to control other contributing costs.

Ultimately, determining the correct course of action with respect to the Bush tax cuts necessitates carefully weighing two needs that are typically viewed as mutually exclusive -- using budgetary measures to stimulate the economy and reducing the deficit. Given that long-term interest rates clearly indicate that markets are not concerned about the deficit, the primary concern must be the economy. The tax cuts therefore should be extended in order to avoid a contraction in demand, critical when the primary problem in the economy today is a lack of demand.