A Taxing Agenda
By Daniel Altman

(Business 2.0) – Iraq has squeezed economic policy out of the headlines, but one big item remains on the Bush administration's domestic agenda: making its tax cuts permanent. As things now stand, most of the cuts enacted since 2001 will expire starting in 2008. Strictly on the economic merits, does it make sense for the cuts to be renewed?

Some of the cuts probably should become permanent. For example, marriage has tangible macroeconomic benefits, so there's no reason to restore the so-called marriage penalty, which caused some couples who filed jointly to pay higher taxes than they would have as individuals. Similarly, little might be gained by eliminating new corporate tax breaks, like the ones that allow businesses to deduct more of their spending on software, equipment, and buildings. It's unclear whether such policies will stimulate capital investment, but they probably won't hurt. Taxing corporate profits, on the other hand, can trigger all kinds of behavior that even the best economists can't predict.

So what about the biggest piece of the puzzle--personal income taxes? The current, lower rates of taxation on ordinary income, dividends, and capital gains would cost the Treasury hundreds of billions of dollars a year. That's fine, so long as the government can still meet its obligations. But if Uncle Sam needs this money, the diminished public coffers can have a very real economic impact.

Social Security and Medicare costs are a giant headache descending on the nation's long-term fiscal health. According to the programs' 2004 annual reports, within three decades, Social Security will face a yearly shortfall equivalent to more than a quarter of the benefits it owes to retirees--$130 billion in today's terms. Payroll taxes earmarked for Medicare won't even cover its spending this year, and the program's trust fund will be exhausted by 2019. Trimming benefits would be political suicide for any lawmaker. Raising payroll taxes isn't the answer either, in part because such flat-rate levies are regressive, and in part because they apply to only one specific type of personal income.

The obvious alternative is to fill the gap by increasing--not cutting--personal income taxes, which have a broader base than payroll taxes. Common sense recommends this as well: If the government will need to plug a 12-figure hole, why offer taxpayers a 12-figure giveback?

But what about the money that you, personally, might receive from a permanent income tax cut? Say you're expecting to earn an average of $150,000 a year for the next 30 years. The tax cuts now save you about $5,000 annually. You know you'll get most of the cuts for the next six years; let's say you also believe there's a 50-50 chance the cuts will remain in place for another 24 years. Last, say that the income you receive today is worth more to you than the income you'll receive in the future. (Economists assume you value those gains at roughly 3 percent less for each successive year.) All told, that means making the tax cuts permanent would have the same effect as giving you $33,000 today. Of course, the lower tax rates might also make for more predictable labor and capital markets--and some of that might benefit you too. Perhaps the whole package is worth a one-time payment of $50,000. Stack that up against the risk that the government may face a major debt crisis, resulting in skyrocketing interest rates on everything from home mortgages to credit cards and small-business loans. Weigh the two alternatives. Then, when you're ready to choose, why not give your congressperson a call?