The CBO on Current Law vs. the President’s Budget

The CBO has just released its assessment of the economic impact of current law, in which all of the 2001/2003/2010 tax cuts expire, as compared to that of President Obama’s budget proposal:

For the 2013–2017 period, under most of the estimates CBO produced using alternative models and assumptions, the President’s proposals would increase real output (relative to that under current law) primarily because taxes would be lower than those under current law, and, therefore, people’s disposable income and their demand for goods and services would be greater.

Over time, however, the proposals would reduce real output (relative to that under current law) because the deficits would exceed those projected under current law, and the effects of increasing government debt would more than offset the favorable effects of lower marginal tax rates on labor income. When the net impact of those two types of effects would shift from an increase in real output to a decrease would depend on various factors, including the impact of increased aggregate demand on output and the effect of deficits on investment.

This reminded me of a post by Josh Barro published in late September of 2010:

In the CBO’s strong labor response model, a full extension of the tax cuts knocks 0.6 percentage points off of GNP, whereas a partial extension as proposed by President Obama (which would raise earned and unearned income tax rates on most filers making over $250,000 per year) would cost 1.2 points of GNP. That is, a partial tax cut extension is worse for the economy than a full extension, even though the full extension grows the national debt by more.

The implication is that the extending the portion of the tax cuts that principally benefits high earners would grow GNP by 0.6 points, despite such an extension’s effects on the deficit. It is the rest of the tax cuts (lower marginal rates in the bottom four brackets, marriage penalty relief, the higher per child tax credit, etc.) that do not stimulate enough economic activity to offset the added debt burden.

Even if you prefer CBO’s weak labor response model (which assumes workers have low sensitivity to tax treatment), the presentation shows equal economic damage from a partial or full extension, despite the fact that a full extension grows the deficit by about a third more than a partial extension. With this assumption, tax cuts for the rich aren’t an economic boon, but they are at least a free lunch.

For obvious political reasons, however, we never hear politicians call for the extension of the high-income rate reductions and the expiration of the rate reductions, deductions, and credits aimed at middle-income households. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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