Dec. 8, 2010 -- Many Americans are breathing a sigh of relief with the proposed two-year extension of the Bush-era tax cuts, but the short-term relief would come at a long-term price for the U.S. budget deficit that looms heavily in the background.
The tax cut extension would cost about $900 billion over the next two years. The number is considerably less than the $4 trillion it would cost for a permanent extension, but comes at a time when the United States is dealing with a $1.3 trillion budget deficit and a $13.8 trillion national debt that it must tackle sooner or later.
Supporters of the extension say it is needed to stabilize the economy in the short term, an argument that President Obama has made consistently in defending the proposal. It is designed to prevent a further decrease in personal spending at a time when Americans are already watching their pocketbooks closely.
Mark Zandi, an economist at Moody's, estimates that extending the federal unemployment insurance benefits for one year and tax cuts for the middle class would create 500,000 more jobs in 2011.
But other economists argue that lawmakers should have devised a plan concurrently with the proposed extension of tax cuts to reduce the debt. The administration and lawmakers must think of a more sustainable strategy for the long term, these experts say.
Extending the tax cuts permanently -- as some conservatives argue should be the case -- without offsetting the cost would add significantly to federal debt in the long term. By 2050, it would increase the debt by an amount roughly equal to the size of the economy, according to long term projections by the Center on Budget and Policy Priorities.
"When the economy is weak, raising taxes to balance the budget is not a sensible thing to do. You don't want to have a hit on the economy," said Roberton Williams, a senior fellow at the non-partisan Tax Policy Center and former deputy assistant director for tax analysis at the Congressional Budget Office.
"When the economy strengthens two or three years down the road, we don't want our hands tied in a way that makes it more difficult to balance the budget," he added. "We really do need to make some tough decisions in the medium term so that we don't have real problems. The sooner we do it the easier it's going to be. The longer we wait the bigger the problem becomes."
The last time a broad-based reform of the U.S. tax code was implemented was 1986, when corporate taxes were increased while individual taxes were lowered.
Economists say another such overhaul is badly needed, but there is little political will to make drastic changes.
Lawmakers are "going to have to have the courage or the bond market is going to create a crisis, and they'll have to respond in a crisis circumstance as has happened in Spain and elsewhere in Europe," said Michael J. Graetz, a professor of law at Yale who specializes in tax policy. "There is a level of debt that's unsustainable and if we don't change the course, we're going to reach that level and at that point people aren't going to lend to us without charging exorbitantly high interest rates."
What Do Tax Cuts Mean for U.S. Deficit Issue?
The debt crisis in Europe has escalated as investors are dumping Spanish and Portuguese bonds amid concerns about credit.
The White House on Tuesday argued that the proposed tax cut extension would not worsen the medium and long-term deficit and that it will in fact boost job growth and the economy in the near term. But Obama also warned that a long-term extension of the tax cut for the wealthy would not bode well for the budget deficit.
Extending all of the tax cuts would increase after-tax income for households at all income levels but gains would be greatest for those at the top of the income distribution ladder, according to the non-partisan Tax Policy Center.
Americans are well aware of the nation's burgeoning deficit problems but people aren't as warm to the idea of increasing taxes or chipping away at costly programs like Medicare and Social Security.
Eighty-five percent of those polled in an AP-CNBC poll released recently said the enormous budget deficit would harm future generations, but even so, 46 percent said education, health and energy programs should grow, even if it worsens the deficit. Forty-seven percent said they should be cut to bring down the deficit.
The biggest challenge for lawmakers and the administration is how to balance cutting the deficit and not upsetting the economy and voters. With the next election looming on the horizon, political jostling is likely to pick up as soon as the tax issue re-emerges in 2012.
And it's not just extending tax cuts that is of concern to economists. With all of the talk of deficit reduction and paying down the debt, members of both parties continue to push legislation that will add to the total, including the Medicare "doc fix" and the food safety bill.
"Clearly the political will is not there. There are plenty of ideas for how to fix the deficit," said Isabel V. Sawhill, a budget expert at the Brookings Institute. "And yet we're not acting on this, and I don't see much hope that we are doing to act on it."