One of the strongest points being made about economic policy is that the Bush tax cuts must be extended because of the economic crises. Yes, standard analysis is that a tax hike in the middle
of an economic downturn is bad policy as far as short run economic stimulous.
But maybe part of our problem is that we constantly let short run considerations overrule long run considerations. This chart of long run projections of federal budget spending makes an interesting point. As the chart shows the long run problem is not social security or standard government spending including defense. There are two long run problems. One is medical spending. the second is interest on the debt and it is actually a larger problem than medical spending.
By the middle of the century interest on the debt is projected to be a larger item in federal government spending than medical care and is the largest single reason this study shows
government’s share of the economy doubling. But the massive increase in interest is the long run cost of the Bush tax package. If the Bush tax cuts were allowed to expire the budget would go into a surplus and the interest on the debt would fall, not increase. Actually, over the long run it would be a large negative below the line that could offset the growth of Medicare and keep total federal spending below 20% of GDP.
So we are back to the fundamental long run question. Yes, maybe allowing the Bush tax cuts to expire would be a poor short run policy. But it would be great long run policy.
Secondarily, it would mean that the US would not have to borrow so much overseas to finance the deficit and the US would not have to run a massive current account deficit. So maybe, if we
allow the Bush tax cuts to expire the current account deficit could turn into a surplus and US
manufacturing and other import substitution industries could generate significant growth.
So it appears rather obvious that the correct long run policy is to allow the Bush tax cuts to expire. So why should we allow short run considerations to overrule good long run policies?