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If You Put Tax Cuts on the National Credit Card, You Can’t Ignore the Interest

August 11, 2010 at 2:19 PM

The Heritage Foundation’s Brian Riedl continues to defend his claim that the Bush tax cuts aren’t a major contributor to current and future deficits. Our analysis shows otherwise.

There are several points of contention, but the most important is whether estimates of the tax cuts’ impact on the deficit should include not only the direct revenue loss but also the extra interest payments on the national debt that result when tax cuts are deficit-financed. He says no; we say yes.

Mr. Riedl claims that the Congressional Budget Office and the Joint Committee on Taxation (whose figures CBO uses in its official cost estimates) exaggerate the revenue loss resulting from the tax cuts because they don’t take into account the effects of the tax cuts in boosting the economy. Excluding the tax cuts’ interest costs, he argues, offsets that overestimate.

We have written file type icon many times about why the “dynamic” effects of tax cuts over time are small at best, and that when the tax cuts are deficit-financed as were the Bush tax cuts, they can hinder economic growth over the long term. (During an economic downturn, temporary deficit-financed tax cuts can stimulate the economy in the short run.)

Various studies — including one by the Bush Administration’s Treasury Department — have shown that any dynamic effects from the Bush tax cuts would have been small over the period since 2001 and may even have been negative, reducing revenues even further.

So, leaving out the indisputable increase in interest costs resulting from the tax cuts — simply because the estimates also omit some highly disputable economic effects — doesn’t produce a better estimate of the effect of the tax cuts on the deficit.

Mr. Riedl also offers another argument: “While the tax cuts certainly contributed to rising net interest costs, the specific impact of a given policy on net interest costs is difficult to estimate. Because CBO avoids such calculations, Heritage’s analysis does [as] well.”

Wrong on both counts. Estimating how a given policy change affects interest costs is far from the most difficult estimating job that budget analysts face, and CBO doesn’t avoid such calculations.

For instance, CBO’s January 2010 Budget and Economic Outlook includes a table (see page 16) that shows the effects of extending the 2001 and 2003 tax cuts — not only the decrease in revenues but also the extra interest payments that would result.

CBO clearly believes that a proper estimate of the tax cuts’ budgetary effects should include interest costs. So do we.