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Monday, December 20, 2010

The Bush Tax Cuts and the Economy


Thomas L. Hungerford
Specialist in Public Finance

A series of tax cuts were enacted early in the George W. Bush Administration by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA; P.L. 108-27). These tax cuts, which are collectively known as the Bush tax cuts, are scheduled to expire at the end of 2010. Beginning in 2011, many of the individual income tax parameters (such as tax rates) will revert back to 2000 levels. The major tax provisions in EGTRRA and JGTRRA that are part of the current debate over the Bush tax cuts are the reduced tax rates, the reduction of the marriage penalty (and increase in the marriage bonus), the repeal of the personal exemption phaseout and the limitation on itemized deductions, the reduced tax rates on long-term capital gains and qualified dividends, and expanded tax credits. This report examines the Bush tax cuts within the context of the current and long-term economic environment.

The U.S. economy entered into a recession in December 2007. Between the fourth quarter of 2007 and the second quarter of 2009, the economy shrank with real gross domestic product (GDP) falling by 4.1%. The unemployment rate increased from 4.9% in December 2007 to 10.1% by October 2009, and is currently still over 9%. As a result of reduced economic activity and government efforts to stimulate the economy, the federal budget deficit increased from 1.2% of GDP in FY2007 to 9.9% of GDP in FY2009. Most economic forecasts suggest the economic outlook over the next few months is not bright and will likely be characterized by high unemployment and sluggish economic growth. The long-term fiscal situation is unsustainable.

There are several options that Congress can consider regarding the Bush tax cuts, and each of the options strikes a different balance between fostering economic growth and restoring fiscal sustainability. Allowing the Bush tax cuts to expire as scheduled will somewhat improve the fiscal condition, but could stifle the economic recovery. At the other extreme, permanently extending all of the Bush tax cuts would not undercut the economic recovery, but would worsen the longer-term fiscal outlook and possibly signal a lack of progress in dealing with the long-term fiscal situation. The Obama Administration has proposed allowing the Bush tax cuts to expire for high income taxpayers and permanently extending the tax cuts for middle class taxpayers. The House passed the Middle Class Tax Relief Act of 2010 (H.R. 4853) on December 2, 2010, which would permanently extended the Bush tax cuts for middle-class taxpayers (single taxpayers with income under $200,000 and married taxpayers with income under $250,000). Compared to permanently extending all of the Bush tax cuts, this proposal is estimated to increase tax revenues by $252 billion over 5 years and by $678 billion over 10 years, but still leaves federal debt on an unsustainable path.

The Obama Administration and the congressional Republican leadership recently agreed to a tax and spending plan that includes a 2-year extension of the Bush tax cuts. The agreement was introduced in the Senate by Senator Baucus as the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. A 2-year extension of the Bush tax cuts could cost $363 billion and increase debt service costs by $138 billion over 10 years. A temporary extension of the Bush tax cuts, however, could provide time for Congress to consider tax reform and also provide a deadline to complete deliberations. Furthermore, allowing the tax cuts targeted to high income taxpayers to expire as scheduled could help reduce budget deficits in the short-term without stifling the economic recovery.



Date of Report: December 10, 2010
Number of Pages: 20
Order Number: R41393
Price: $29.95

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