Deficit talks bring effect of tax cuts center stage

Whether they ‘pay for themselves’ contested

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The fast-approaching Capitol Hill battles on spending and deficit-reduction are going to test the notion that tax cuts pay for themselves - as both parties have started staking out ground in a debate over whether such cuts generate a big enough uptick in economic activity to offset the loss of revenue.

Democrats say that if lawmakers are serious about tackling the $14.3 trillion national debt, they must pair spending cuts with tax increases, particularly on wealthier Americans.

Republicans, meanwhile, say lawmakers would be better served pairing deeper spending cuts with a permanent extension of the Bush-era tax cuts, arguing that the combination will stimulate the economy, broaden the tax base, and help make up for any revenue loss.

The diverging views are at the center of the spending debate on Capitol Hill that will determine the nation’s fiscal path and the amount of debt passed on to future generation.

Last week, the philosophies were on full display at a House Ways and Means hearing after Rep. Charles B. Rangel prodded some tax experts for an answer as to whether tax cuts pay for themselves.

“The typical tax cut does not pay for itself,” Alan D. Viard, a scholar at the American Enterprise Institute whom the Republicans called to testify, told the New York Democrat.

“I do think it’s important to realize that if there is a marginal rate reduction in the tax cut that you normally do get an increase in economic activity,” he said, and this helps revenues some, but the effect “is not large enough to offset the direct revenue loss and therefore you do have a net reduction in revenue from the tax rate cut.”

But Rep. Tom Price, Georgia Republican, countered by pointing out that after Congress adopted tax cuts under Presidents John F. Kennedy, Ronald Reagan and George W. Bush “there was an increase in revenue to the federal government following tax reductions by each of those administrations.”

Asked about Mr. Price’s statement in a follow-up interview with The Washington Times, Mr. Viard said that sort of “before and after comparison is kind of ridiculous,” explaining that revenues and economic growth are affected by many factors besides tax rates.

“It suggests that every event in the world must increase revenue because the nominal revenues, with rare exceptions, climbed over time, no matter what’s been happening,” Mr. Viard told The Times, adding that while lower tax rates will yield more economic activity, economists generally agree they don’t pay for themselves.

“Obviously if you have the opportunity to raise revenue by lowering tax rates than you’d want to do that,” he said. “But you do have to accept the reality that we are not in that situation, that we are in a position where cutting taxes is going to lose revenue, while raising taxes would gain revenue.”

Despite a general consensus among economists, Robert L. Bixby, executive director of the Concord Coalition, which advocates for reducing the federal deficit, some lawmakers have allowed the notion to muddy the debates over spending.

“They will leave that impression that tax cuts pay for themselves by saying lower taxes improve the economy and, by sort of having it linger out there, it leaves the impression that that must mean revenues would improve,” he said.

Last year, Democrats and Republicans staked out similar positions in the fight over extending the Bush-era tax cuts, which were scheduled to expire at the end of 2010.

While both parties eventually agreed that raising taxes could jeopardize the fragile economic recovery, they sparred over how the tax cuts contributed to the national debt and whether the country could afford to permanently extend all the tax cuts, to top income earners, giving up an estimated $700 billion over the next 10 years.

Douglas Elmendorf, director of the Congressional Budget Office, testified before Congress last year that the larger and longer the tax cuts, the worse the long-run deficit effects become, since added federal deficits eventually crowd out private investment.

He also said there’s a substantial margin of error in the predictions of how the economy will respond to tax cuts, because it depends greatly on how taxpayers respond to having more money in their pockets  save it, spend it or invest it.

Congress eventually agreed to extend the tax cuts for two years, pushing the fight into current debates over 2012 spending levels and the fast-approaching deadline for Congress to raise the nation’s borrowing limit.

David Stockman, the budget director under President Ronald Reagan, said the current battles over taxes, spending and deficits put Congress in a tough spot because raising taxes can hurt investment and growth, but reducing revenue streams can generate deficits that result in higher inflation and decreased interest rates.

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