What will deal on Bush tax cuts mean for the federal deficit?

Extending the Bush tax cuts will prevent as much as $300 billion a year from going into federal coffers, continuing the current federal deficits.

On the surface it seems like it could be a pair of big holiday gifts from Congress: the Bush tax cuts to be extended for all income levels – millionaires to middle class – and the unemployed get another 13 months of emergency unemployment compensation.

But, how much will the gifts cost the taxpayers in the form of a higher budget deficit?

The short answer is: it depends on how you view Congress’s actions.

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Looking at the moves as an extension of current law gives one answer. But, viewing the legislation in terms of current policy gives quite another.

What’s the difference? For example, under current law, the tax cuts will expire at the end of this calendar year. Extending them means the budget deficit would rise from what had been expected. This is the way the Congressional Budget Office, the official scorer of budget items, looks at the budget.

However, if the extension of the tax cuts is viewed in the light of current policy, then it makes no difference to the budget deficit because the baseline remains the same. In other words, extending the Bush era tax cuts won’t cause the deficit to rise.

“The cost of the tax cuts depends on the baseline,” says Stan Collender, a partner at Qorvis Communications in Washington and a budget expert.

Thus, on the basis of current law, in 2011 the extension of the Bush tax cuts to all Americans would result in a $200 billion to $300 billion cost to the US Treasury compared to what had been expected. Extending the cuts to households making over $250,000 a year accounts for $32 billion of that.

Over 10 years, the total revenue loss from the tax cuts comes to $3.9 trillion, according to the US Treasury.

But, viewing the budget differently, as a reflection of current policy, means the tax cuts don’t “cost” the US Treasury revenues.

“The purpose of a budget baseline is to show what the budget would look like if we kept today’s policies in place,” argues Brian Riedl, a budget analyst at the Heritage Foundation, a conservative think tank.

Here’s an example of why he argues the baseline should be based on current policy instead of current law: to Reidl and the Republicans, the return to the pre-Bush era tax rates is a tax hike, however under current law, the expiration of the Bush era tax cuts is not considered a tax hike because they were previously scheduled to expire.

He says the logic of looking at the budget from the perspective of current law gets really stretched if applied to programs such as farm subsidies, food stamps and no-child left behind, all of which are scheduled to expire in 2012 and all of which most likely will be renewed by Congress. Under current law baseline the programs would be dropped from the budget, but under a policy baseline they would be included.

Estimating the federal budget deficit in the coming years gets even more complicated. As part of its negotiations, Congress over the next several weeks will have to decide whether to renew the exemption from the Alternative Minimum Tax (AMT) for certain tax filers. Congress introduced the AMT to assure that high income households, which had many deductions, paid at least some taxes, but it never indexed it for inflation. To renew the AMT fix would cost the Treasury $658 billion over a 10 year period, using current law as a baseline.

“If Congress does nothing, some 20 million filers will be hit by the AMT when the intention was for only 4 million households to get hit by it,” says Pete Davis, president of Davis Capital Investment Idea, a Washington consulting firm.

In addition, extending emergency unemployment benefits will cost about $5 billion per month under current law. There are also 83 different tax provisions, such as a Research & Development tax credit, that will expire. Renewing all of them would add another $30 billion to the deficit.

“Will it renew all of these and not pay for them?” asks Mr. Davis.