WASHINGTON — Members of Congress need to suspend their political squeamishness on tax increases and allow the Bush-era tax cuts to expire in 2012 if they are serious about federal deficit reform, a research group reported Thursday.
The expiration of the tax cuts would likely boost demand for municipal bonds, according to market sources. Part of the weakness in the muni market since the beginning of the year stems from the Congress’ two-year extension of Bush tax cuts in December, they said. The tax cuts were initially enacted in 2001 and 2003.
The report, published by the Center on Budget and Policy Priorities, said that to stabilize the federal deficit and to reassure financial markets, the total budget deficit should be no more than 3% of gross domestic product. One of the simplest solutions for reaching this goal would be to allow all the tax cuts enacted under the administration of George W. Bush to expire at the end of 2012, it said.
In its first estimate after the tax cuts were extended, the Congressional Budget Office in January estimated that the fiscal 2011 deficit would be about $1.5 trillion, or 9.8% of GDP. This figure is up from the 7.0% deficit-to-GDP estimate the CBO made in August.
The cost of the federal deficit is only going to get worse, budget office said. As the economy recovers and as interest rates increase, interest payments on the federal debt “are poised to skyrocket over the next decade,” it said.
If all the tax cuts expire in 2012, not just the tax cuts for those making $250,000 a year or more, the deficit would be cut “nearly in half,” Robert Greenstein, CBPP’s lead author of the report, told reporters.
“We could almost stabilize the debt with this one step,” he said. While there is “little political support” for the expiration of the tax cuts, Greenstein said it is “likely the only way” to stabilize the deficit “without draconian cuts” in spending.
A reset of the tax brackets to their levels during the Bill Clinton administration “would certainly help stoke the demand for municipals again,” said John Hallacy, head of municipal research at Bank of America Merrill Lynch.
“Everybody is looking at the federal deficit and saying, 'How long this can go on?’” he said, adding that the looming deficit may make it “more difficult to avoid” tax hikes.
The CBPP report also recommends that members of Congress scale back tax breaks written into the tax code for particular individuals or businesses. By removing these “tax expenditures” the government could save more than $1 trillion in a year. The plan also calls for slowing the cost of health care and capping certain discretionary spending programs.
The CBPP report comes about three months after President Obama’s commission on deficit reform, which made similar recommendations on tax expenditures and health care costs. The report, led by Democrat Erskine Bowles and Republican Alan Simpson, suggested tax-exempt interest on new municipal bonds could be eliminated, along with other tax reforms.
Greenstein said he would be “very concerned” that killing tax-exempt interest for new bonds would hurt state and local governments, most of which are facing growing budget shortfalls. The CBPP did not include such a recommendation in its report.
Some lawmakers are threatening to vote against an increase to the federal debt limit unless changes are made immediately to improve the U.S. fiscal condition. Sen. Joe Manchin, D-W.Va., said earlier this month that he plans to vote against the debt limit increase “unless the vote is linked to a real budget plan that begins to fix our fiscal mess.”
The government could reach the current statutory limit of $14.294 trillion as early as April 15, the Treasury Department said March 1. The Treasury is expected to revise its estimate early next month.