The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

.

The 2001 and 2003 Bush Tax Cuts and Deficit
Reduction
Thomas L. Hungerford
Specialist in Public Finance
July 23, 2012
Congressional Research Service
7-5700
www.crs.gov
R42020
CRS Report for Congress
Pr
epared for Members and Committees of Congress
c11173008

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Summary
A series of tax cuts were enacted early in the George W. Bush Administration by the Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax
Relief Reconciliation Act of 2003 (JGTRRA). These tax cuts, which are collectively known as the
Bush tax cuts, were originally scheduled to expire at the end of 2010. These tax provisions were
extended until the end of 2012 at an estimated cost of $408 billion. Beginning in 2013, many of
the individual income tax parameters (such as tax rates) will revert back to 2000 levels. One
legislative proposal introduced in the 112th Congress, H.R. 6104 (introduced by Representative
Cedric Richmond), would extend the 2001, 2003, and 2009 tax cuts for taxpayers with income
below $500,000 for another year. A bill introduced by Senator Harry Reid (S. 3412) would extend
the tax cuts for taxpayers with income below $200,000 (for singles) or $250,000 (for married
couples) for another year, but set a top income tax rate on qualified dividends of 20%. A bill
introduced by Senator Orrin Hatch (S. 3413) would extend the tax cuts for all taxpayers for
another year.
The 2010 debate over the fate of the Bush tax cuts took place when the economy was
underperforming, the unemployment rate was high, and the federal deficit was large. The U.S.
economy was in a severe recession from December 2007 to June 2009. The unemployment rate
reached a high of 10.2% in October 2009, and it is currently still over 8%. As a result of reduced
economic activity and government efforts to stimulate the economy, the federal budget deficit
increased from 1.2% of GDP in FY2007 to 9.9% of GDP in FY2009. Most economic forecasts
suggest the economic and budget outlook will likely be characterized by high unemployment,
sluggish economic growth, and relatively large budget deficits. Consequently, the 2012 debate
over the fate of the Bush tax cuts is also likely to take place in a bleak economic and fiscal
environment.
There are several options that Congress may consider regarding the Bush tax cuts, and each of the
options strikes a different balance between fostering economic growth and restoring fiscal
sustainability. Allowing the Bush tax cuts to expire as scheduled will somewhat improve the
fiscal condition by increasing tax revenue, but could retard the economic recovery. At the other
extreme, permanently extending all of the Bush tax cuts would not undercut the economic
recovery, but would somewhat worsen the longer-term fiscal outlook and possibly signal a lack of
progress in dealing with the long-term fiscal situation. Permanently extending the Bush tax cuts
could increase federal debt by almost $3 trillion over the next 10 years.
It is often argued that increasing tax rates will reduce consumer spending in the short term, and
work effort, saving, and investment—all key components of economic growth—in the long term.
In an underemployed economy, short-term spending increases and tax cuts are expected to
facilitate job creation, reduce unemployment, and increase output. The main argument against
allowing the Bush tax cuts to expire at the end of 2010 was the weak recovery and the fear of
pushing the economy back into recession, an argument likely to be made in 2012. Once the
economy has recovered from the recession, however, long-term economic growth will be
facilitated by increasing work effort, saving, and investment. It is often argued that increasing tax
rates will reduce these long-term economic growth components. Economic research, however,
suggests that modest tax rate increases would have little negative impact on long-term economic
growth and job creation.
Congressional Research Service

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Contents
The Economic Environment ............................................................................................................ 1
The Budgetary Environment............................................................................................................ 3
The Bush Tax Cuts........................................................................................................................... 6
Revenue Cost from Extending the Bush Tax Cut Provisions .................................................... 7
Distributional Effects of the Bush Tax Cut Provisions.............................................................. 9
Options Regarding the Bush Tax Cuts........................................................................................... 10
Long-Term Economic Effects of Tax Rate Increases..................................................................... 13
Work Effort.............................................................................................................................. 13
Saving and Investment ............................................................................................................ 14
Concluding Remarks ..................................................................................................................... 15

Figures
Figure 1. Monthly Unemployment Rate and Long-Term Unemployment Rate, 1948-2012.......... 2
Figure 2. Deficits as a Percentage of GDP,
2007-2009 Recession Compared with Prior Recessions .............................................................. 4
Figure 3. Debt Held by the Public as a Percentage of GDP, 1790-2021.......................................... 5
Figure 4. Federal Surpluses(+)/Deficits(-) as a Percentage of GDP, Two Scenarios ....................... 7
Figure A-1. Lorenz Curves of Bush Tax Cut Provisions, 2012 ..................................................... 18

Tables
Table 1. Revenue Estimates of Bush Tax Cut Provisions: Effect on Deficit FY2013-
FY2022 ......................................................................................................................................... 8
Table 2. Percentage Change in After-Tax Income Due to Bush Tax Cut Provisions, by
Income Category......................................................................................................................... 10
Table 3. Revenue Gain and Deficit Reduction from Expiration of Bush Tax Cuts for
High-Income Taxpayers.............................................................................................................. 12

Appendixes
Appendix. The Suits Index ............................................................................................................ 17

Contacts
Author Contact Information........................................................................................................... 18
Congressional Research Service

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

series of tax cuts were enacted early in the George W. Bush Administration by the
Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16)
A and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA; P.L. 108-27).
These tax cuts, which are collectively known as the Bush tax cuts, were originally scheduled to
expire at the end of 2010. In addition to the Bush tax cuts, two tax provisions enacted in the
American Recovery and Reinvestment Act of 2009 (ARRA; P.L. 111-5)—an increase in the
earned income tax credit and an increase in eligibility for the refundable portion of the child tax
credit—were scheduled to expire at the end of 2010. In a lame-duck session in December 2010,
the Bush tax cuts and the two ARRA provisions were extended for two years at an estimated cost
of $408 billion.1 Beginning in 2013, many of the individual income tax parameters (such as tax
rates) are scheduled to revert back to 2000 levels. One legislative proposal introduced in the 112th
Congress, H.R. 6104 (introduced by Representative Cedric Richmond), would extend the 2001,
2003, and 2009 tax cuts for taxpayers with income below $500,000 for another year. A bill
introduced by Senator Harry Reid (S. 3412) would extend the tax cuts for taxpayers with income
below $200,000 (for singles) or $250,000 (for married couples) for another year, but set a top
income tax rate on qualified dividends of 20%. A bill introduced by Senator Orrin Hatch (S.
3413) would extend the tax cuts for all taxpayers for another year.
The pending expiration of the Bush tax cuts generated a great deal of attention in 2010 as
reflected by editorials and opinion pieces in national newspapers, and congressional hearings. The
proposals regarding the Bush tax cuts were generally not about whether to let the tax cuts expire
as scheduled, but rather about which tax cuts to extend and for how long. Many policy makers
argued that raising taxes could impede the fragile economic recovery from the severe 2007-2009
recession.
The major tax provisions in EGTRRA and JGTRRA and the tax provisions in ARRA that are part
of the current debate over the Bush tax cuts are the reduced individual income tax rates, the
reduction of the marriage penalty (and increase in the marriage bonus), the repeal of the personal
exemption phaseout and the limitation on itemized deductions, the reduced tax rates on long-term
capital gains and qualified dividends, and expanded tax credits. Other provisions that were
included in EGTRRA and JGTRRA, such as the estate tax, are not considered in this study. This
report examines the Bush tax cuts within the context of the current and long-term economic and
budgetary environment.
The Economic Environment
The recession beginning in December 2007 is the most severe recession since the Great
Depression and has been referred to as the Great Recession. Between the fourth quarter of 2007
and the second quarter of 2009, the economy shrank with real gross domestic product (GDP)
falling by 5.1%. The unemployment rate increased from 4.9% in December 2007 to 10.1% by
October 2009, and still is over 8%. As a result of reduced economic activity and government
efforts to stimulate the economy, the federal budget deficit increased from 1.2% of GDP in
FY2007 to 9.9% of GDP in FY2009. The economic recovery, however, remains fragile and the
labor market has not recovered.

1 Joint Committee on Taxation, Estimated Budget Effects of the “Tax Relief, Unemployment Insurance Reauthorization,
and Job Creation Act of 2010,” Scheduled for Consideration by the United States Senate, JCX-54-10, December 10,
2010.
Congressional Research Service
1

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Two common measures of weakness in the labor market are the unemployment rate and the
proportion of the labor force that has been unemployed for at least six months (the long-term
unemployed). Figure 1 displays the monthly unemployment and long-term unemployment rates
since 1948. The long-term unemployment rate has generally tracked the unemployment rate over
the business cycle. Over a business cycle, the long-term unemployment rate is at its lowest point
at or near the beginning of a recession and then reaches a peak a few months after the end of the
recession (typically within six months). Like the unemployment rate, the long-term
unemployment rate is a lagging indicator—the labor market does not begin to recover from the
recession until some time after the official end of the recession. After the 1990-1991 and 2001
recessions, however, the long-term unemployment rate did not reach its peak until 15 months and
19 months, respectively, after the recession ended. The long-term unemployment rate is currently
higher than at any time over the past 62 years—in June 2012, 3.5% of the labor force or about
42% of the unemployed had been out of work for six months or more.
Figure 1. Monthly Unemployment Rate and Long-Term Unemployment Rate,
1948-2012
12%
10%
8%
ce
For
Labor
6%
age of
cent
Per
4%
2%
0%
Jan-48 Jan-52 Jan-56 Jan-60 Jan-64 Jan-68 Jan-72 Jan-76 Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08 Jan-12
Recessions
Unemployment Rate
Long-term Unemployment Rate

Source: CRS analysis of Bureau of Labor Statistics data.
The economic outlook over the next few months is not bright and will likely be characterized by
high unemployment and sluggish economic growth. For example, the Blue Chip consensus
forecast has the unemployment rate staying above 8% until through 2012.2 And Carmen Reinhart

2 Blue Chip Economic Indicators, vol. 37, no. 7 (July 10, 2012).
Congressional Research Service
2

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

and Vincent Reinhart show that real per capita GDP growth rates tend to be low during the decade
following a severe financial crisis and synchronous world-wide shocks.3
The Budgetary Environment
Before the Bush tax cuts were enacted, the Congressional Budget Office (CBO) projected
gradually rising federal budget surpluses—from 2.7% of GDP in 2001 to 5.3% of GDP by 2011.4
Within a few years, CBO was projecting budget deficits. The Bush tax cuts, with a $1 trillion 10-
year price tag, contributed to this shift from budget surpluses to deficits. Other major contributing
factors included the 2001 recession, the increase in defense spending for the wars in Iraq and
Afghanistan, and the Medicare prescription drug benefit (enacted in the Medicare Prescription
Drug, Improvement, and Moderation Act of 2003; P.L. 108-173). By the time the 2007-2009
recession started, CBO was projecting deficits between FY2008 and FY2011 equivalent to over
1% of GDP (with budget surpluses after 2011).5
Nonetheless, federal budget conditions before the 2007-2009 recession were not much different
from the conditions before previous recessions. Figure 2 shows the budget deficit as a percentage
of GDP for three years—the fiscal year before the start of the recession, the fiscal year in which
the recession started, and the next fiscal year. The 2007-2009 recession is compared with the
average of the prior six recessions. In the year before the Great Recession (2006), the budget
deficit was 1.2% of GDP compared with 1.6% of GDP, on average, for the previous six
recessions.
The situation, however, is very different for the next two fiscal years. The federal deficit
increased to 3.2% of GDP in the year the 2007-2009 recession started (compared with 1.4% of
GDP for previous recessions) and then to almost 10% of GDP in the next year (compared with
2.2% of GDP in previous recessions). The dramatic increase in the federal deficit after 2007 is
due to the depth of the recession and the federal government’s efforts to promote economic
recovery, such as the Economic Stimulus Act of 2008 (P.L. 110-185) and the American Recovery
and Reinvestment Act of 2009 (P.L. 111-5).

3 Carmen M. Reinhart and Vincent R. Reinhart, “After the Fall,” presented at the Federal Reserve Bank of Kansas City
Jackson Hole Symposium, Jackson, WY, August 26-28, 2010.
4 CBO, The Budget and Economic Outlook: Fiscal Years 2002-2011, January 2001.
5 CBO, The Budget and Economic Outlook: Fiscal Years 2008 to 2018, January 2008.
Congressional Research Service
3

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Figure 2. Deficits as a Percentage of GDP,
2007-2009 Recession Compared with Prior Recessions
12%
10%
8%
P
GD
6%
age of
nt
erce
P
4%
2%
0%
Year Before Recession
Year Recession Started
Year After Recession Started
Past 6 Recessions
07-09 Recession

Source: CRS calculations based on OMB data.
The deficit is just one facet of the fiscal condition. Another is federal debt held by the public.
Figure 3 displays federal debt held by the public as a percentage of GDP from 1790 to 2011 and
CBO’s baseline projection for 2011 to 2021. Federal debt in 2009 was equal to 53% of GDP—a
level higher than at any time in U.S. history except for World War II. Between 2007 and 2009,
federal debt increased by almost 17% of GDP. Most large increases in debt have been due to wars
(the Civil War, World War I, and World War II) and to the Great Depression, but debt also
increased dramatically between 1981 and 1994—by 23%—when taxes were reduced and defense
spending increased. Debt as a percentage of GDP is expected to fall after 2013 in CBO’s baseline
projection as the economy strengthens and after the Bush tax cuts expire and the alternative
minimum tax (AMT) reverts back to its 2000 parameters and affects a larger proportion of
taxpayers.6

6 The Tax Policy Center estimates that 28.5 million taxpayers would be subject to the AMT without the annual AMT
fix. In 2009, 4 million taxpayers were subject to the AMT. See Tax Policy Center, Aggregate AMT Projections, 2009-
2020, Table T10-0106, May 3, 2010.
Congressional Research Service
4

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Figure 3. Debt Held by the Public as a Percentage of GDP, 1790-2021
120
World War II
100
80
P
D
G
of
ge
60
ta
n
e
rc
e
Great Depression
P
1941
40
World War I
Civil War
2007
20
1929
1860
1916
0
1790
1820
1850
1880
1910
1940
1970
2000
Year

Source: CBO and OMB.
The United States has been running budget deficits since 2002, but has been running particularly
large budget deficits since 2008. This has occurred because of the severe 2007–2009 recession
and the turmoil in the financial and housing markets, which increased spending and reduced
revenues due to the automatic stabilizers triggered by the recession, and legislation passed in
response to the recession. After the economic recovery picks up steam, the relatively large budget
deficits are unlikely to be replaced with budget surpluses. The main reasons are the steady
increase in real per capita health care spending, which affects Medicare and Medicaid, and the
retirement of the large baby-boom generation, which affects the two health care programs as well
as Social Security. Of course, it is very difficult to predict the future course of the economy and
defense needs.
In a long-term budget projection, CBO projects budget deficits and federal debt for the next 75
years under two fiscal scenarios.7 The first scenario is the baseline or current law. This scenario
assumes that current law is not changed, discretionary spending grows with inflation until 2021
and then with GDP thereafter, and Medicare spending will be constrained somewhat by the
“sustainable growth rate” (SGR) mechanism, which would control the fees paid for physician’s
services.
The second scenario is CBO’s alternative fiscal scenario. This scenario is basically a current
policy scenario where discretionary spending grows with GDP, the Bush tax cuts are extended

7 CBO, CBO’s 2011 Long-Term Budget Outlook, June 2011, table 1.1 for assumptions about spending and revenues
under each scenario.
Congressional Research Service
5

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

and the AMT is indexed until 2021 with revenues remaining as a constant share of GDP
thereafter, and Medicare’s payment rate for physicians remains at current levels. Many argue this
is a more realistic picture of the future budget than the baseline scenario.
Under the baseline scenario, publicly held debt increases from its current level to 84% of GDP by
2035 and then remains fairly constant thereafter. Under CBO’s alternative fiscal scenario,
however, debt as a percentage of GDP reaches 109% of GDP by 2023 (about the same level as in
1946) and 190% of GDP by 2035—extraordinary levels that are unprecedented for the United
States. If the effects of slower growth due to higher debt levels under the alternative fiscal
scenario are incorporated, the debt-to-GDP ratio could reach 250%.8
The Bush Tax Cuts
Several tax provisions were included in EGTRRA, JGTRRA, and ARRA. However, only a few
are the focus of debate:
• the 10%, 25%, and 28% tax rates—the 10% tax rate was introduced and the 28%
and 31% tax rates were reduced to 25% and 28%, respectively;
• the 33% and 35% tax rates—the 36% and 39.6% tax rates were reduced to 33%
and 35%, respectively;
• the reduced marriage penalty—expanded the 15% tax bracket and increased the
standard deduction for couples;
• the repeal of the personal exemption phaseout (PEP) and the limitation on
itemized deduction (Pease)—both PEP and Pease were gradually phased out and
eliminated in 2010;9
• the reduced long-term capital gains tax rate—tax rate was reduced from 10% and
20% to 0% and 15%;10
• the reduced tax rate on qualified dividends—qualified dividends are taxed at
long-term capital gains tax rates rather than at the same tax rates as ordinary
income; and
• the expanded tax credits—the child tax credit, the earned income tax credit
(EITC), and education incentives were expanded.11
The Bush tax cuts are currently scheduled to expire at the end of 2012, and the tax parameters
revert back to their 2000 values (the current law baseline). Figure 4 displays the trend in federal
deficits as a percentage of GDP from 1980 to 2021. Under current law, the federal deficit is
projected to decline from 8.5% of GDP in 2011 to less than 2% of GDP in 2021. If the Bush tax

8 CBO, CBO’s 2011 Long-Term Budget Outlook, June 2011, p. 31.
9 For more information, see CRS Report R41796, Deficit Reduction: The Economic and Tax Revenue Effects of
Personal Exemption Phaseout (PEP) and Limitation on Itemized Deductions (Pease), by Thomas L. Hungerford.
10 For more information, see CRS Report R40411, The Economic Effects of Capital Gains Taxation, by Thomas L.
Hungerford.
11 For more information, see CRS Report R41999, The Impact of Refundable Tax Credits on Poverty Rates, by Margot
L. Crandall-Hollick.
Congressional Research Service
6

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

cuts are permanently extended, the deficit is projected to be 3.4% of GDP in 2021. This
projection, however, does not take into consideration likely annual changes to the alternative
minimum tax (AMT), with a projected 10-year cost of about $1,500 billion. Under CBO’s
baseline projection, the 10-year (FY2012-FY2021) total federal budget deficit is $3,487 billion.
The projected 10-year deficit total jumps to $8,134 billion if the Bush tax cuts are extended at
least through 2021 and the AMT is indexed for inflation.
Figure 4. Federal Surpluses(+)/Deficits(-) as a Percentage of GDP, Two Scenarios
4
2
0
Current Law
P
-2
GD
-4
tage of
n
Extension of
rce
Tax Cuts
-6
Pe
-8
-10
-12
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
2020
Fiscal Year

Source: CRS analysis of CBO and JCT estimates.
Revenue Cost from Extending the Bush Tax Cut Provisions
The estimated budgetary costs of permanently extending the provisions of the Bush tax cuts are
reported in Table 1. Over five years (FY2013-FY2017), extending the provisions is estimated to
reduce tax revenues by $1,022 billion. The 10-year (FY2013-FY2022) revenue loss is estimated
to be $2,375 billion. Debt service costs associated with permanently extending the Bush tax cuts
are also reported in Table 1. Over the 10-year budget window, debt service costs are estimated to
be $451 billion. Furthermore, the AMT, which is likely to be indexed to inflation, interacts with
the extension of the Bush tax cuts. The last row of Table 1 reports the combined costs of indexing
the AMT, extending the Bush tax cuts, and associated debt service, which is estimated to be
$4,761 billion over 10 years—more than double the total projected budget deficits over that
period.
Congressional Research Service
7

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Table 1. Revenue Estimates of Bush Tax Cut Provisions: Effect on Deficit FY2013-FY2022
(billions of dollars)
Provision 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2013-17
2013-22
American
-2.5 -12.4 -12.5 -12.6 -13.1 -13.4 -14.0 -14.3 -14.8 -15.2 -53.1 -124.8
Opportunity
Tax Credit
Education
-0.8 -1.8 -1.9 -2.0 -2.1 -2.2 -2.2 -2.4 -2.5 -2.6 -8.6 -20.5
Provisions
Child Tax
-7.0 -45.6 -46.2 -46.9 -47.2 -47.7 -48.0 -48.2 -48.4 -49.9 -192.9 -435.1
Credit
Earned Income
-0.1 -10.0 -10.2 -10.3 -10.5 -10.7 -10.8 -11.0 -11.1 -11.4 -41.1 -96.1
Tax Credit
Reduced
-4.7 -6.7 -6.4 -6.2 -6.0 -5.7 -5.4 -5.2 -5.0 -5.2 -30.0 -56.5
Marriage
Penalty
10%
Tax
Rate -31.9 -45.8 -46.0 -46.2 -46.1 -45.9 -45.8 -45.6 -45.4 -46.8 -216.0 -445.5
25, 28, 33, and
-37.1 -56.9 -62.1 -67.3 -71.9 -76.6 -80.8 -85.2 -89.9 -92.6 -295.3 -720.4
35% Tax Rates
PEP
and
Pease -5.5 -12.0 -13.6 -15.0 -16.4 -17.6 -18.9 -20.2 -21.5 -22.2 -62.5 -162.9
Lower Rate on
-13.0 -11.9 -30.3 -31.9 -33.7 -35.3 -35.8 -38.2 -39.9 -41.1 -120.8 -311.1
Capital Gains
and Dividends
Other
-0.1 -0.3 -0.3 -0.3 -0.3 -0.3 -0.2 -0.2 -0.2 -0.2 -1.3 -2.4
Provisions
Total
-102.7 -203.4 -229.5 -238.7 -247.3 -255.4 -261.9 -270.5 -278.7 -287.1 -1,021.6 -2,375.2
Debt
service -1.0 -4.5 -9.6 -21.4 -35.1 -48.7 -62.4 -76.0 -89.5
-102.5 -71.6 -450.7
Total plus
-233.3 -311.0 -356.5 -397.6 -443.3 -493.6 -544.5 -600.0 -659.6 -721.7 -1,741.7 -4,761.1
AMT indexed
for inflation
with debt
service
Source: Joint Committee on Taxation, Congressional Budget Office, and CRS calculations (FY2022).

CRS-8

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Distributional Effects of the Bush Tax Cut Provisions
The various provisions making up the Bush tax cuts have different distributional impacts. Table 2
reports what the percentage change in after-tax income for each the tax provision would be in
2012.12 The baseline is a situation in which the Bush tax cuts had been allowed to expire. This
estimate provides information on who benefits from each provision and by how much. The Suits
index is also calculated and reported for each provision. The Suits index is a measure of the
progressivity of tax benefits and varies between -1 (completely regressive) and +1 (completely
progressive).13 The Suits index is negative (and tax benefits are regressively distributed) if the
benefits from the provision are predominately received by taxpayers in the upper part of the
income distribution. It is positive if the benefits predominately go to lower-income taxpayers. It is
zero if the benefits are proportionately distributed throughout the income distribution.
The second and third columns in Table 2 report the distributional effects of extending the reduced
tax rate provisions. The two columns split the tax rate reductions into those targeting lower- and
middle-income taxpayers and those targeting high-income taxpayers. Extending the 10%, 25%,
and 28% tax rates benefits taxpayers throughout the income distribution (see column 2). The
Suits index is slightly positive (0.0895) but is much closer to zero than to one—the benefits are
slightly progressive but close to being proportional. The benefits of extending the 33% and 35%
tax rates are entirely confined to the richest 5% of taxpayers (see column 3) and the richest 1%
would see their after-tax income increase by about 2% (or about $21,500). The Suits index is
−0.7979, suggesting that the benefits are highly regressive.
Extending the repeal of PEP and Pease would also benefit high-income taxpayers (the richest
5%)—the benefits are very regressively distributed (the Suits index is −0.7325). The reduced tax
rates on capital gains and dividends (see columns 5 and 6) primarily benefit upper-income
taxpayers and are regressively distributed. The reduced rates on capital gains benefits the upper
60% of the income distribution but the richest 1% see the largest increase in after-tax income
while the reduced dividends tax rates benefits the upper 20%. In both cases, the Suits index is
negative.
Extending the reduction in the marriage penalty would benefit married taxpayers throughout the
income distribution. The Suits index is 0.1048, suggesting that the benefits are slightly
progressive, but close to being proportional. The extension of the expanded tax credits primarily
benefits taxpayers below the 80th percentile in the income distribution. The Suits index (0.6733)
shows that the benefits are progressively distributed.

12 The estimates were prepared by the Urban-Brookings Tax Policy Center.
13 See the Appendix for more details on the Suits index.
Congressional Research Service
9

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Table 2. Percentage Change in After-Tax Income Due to Bush Tax Cut Provisions,
by Income Category
Reduced
Tax
Reduced
Reduced
Rates:
Tax
Capital
Average
10%,
Rates:
Gains
Reduced
Reduced Expanded
After-
Income
25%,
33%,
Repeal
Tax
Dividends Marriage
Tax
Tax
Category
28%
35%
PEP/Pease
Rate
Tax Rate
Penalty
Credits
Income
Poorest
0.1 0.0 0.0 0.0 0.0 0.2 0.9 $10,702
Quintile
Quintile 2
1.0
0.0
0.0
0.0
0.0
0.3
1.3
$23,359
Quintile 3
1.3
0.0
0.0
0.1
0.0
0.1
0.7
$38,362
Quintile 4
1.3
0.0
0.0
0.1
0.0
0.4
0.4
$61,176
80-90
1.6 0.0 0.0 0.1 0.1 0.7 0.1 $88,999
percentile
90-95
1.8 0.0 0.0 0.2 0.1 0.5 0.0
$124,146
percentile
95-99
1.5 0.1 0.3 0.4 0.2 0.3 0.0
$213,506
percentile
Richest
0.3 1.9 0.9 1.3 0.8 0.1 0.0
$1,071,100
1%
Al 1.2
0.3
0.2
0.3
0.2
0.3
0.3
$58,277
Suits
0.0895 -0.7979 -0.7325 -0.5768 -0.6641 0.1048 0.6733

index
Source: CRS analysis of Tax Policy Center estimates.
With the benefits of the different tax provisions accruing to taxpayers in different parts of the
income distribution, decisions regarding the Bush tax cut provisions will affect income inequality.
In a recent article, Hungerford examined the impacts of various tax provisions (including selected
provisions of the Bush tax cuts) on income inequality.14 The results show that the reduction in the
tax rates increased income inequality, as did the reduction in the capital gains and dividends tax
rate and the repeal of PEP and Pease. Both the child tax credit and earned income tax credit
(EITC) reduce income inequality.
Options Regarding the Bush Tax Cuts
There are several options that Congress may consider regarding the Bush tax cuts. The two
extreme options have been discussed along the following lines. Allowing the Bush tax cuts to
expire as scheduled will somewhat improve the fiscal condition, but could stifle the economic
recovery. At the other extreme, permanently extending all of the Bush tax cuts would not
undercut the economic recovery, but would worsen the longer-term fiscal outlook and possibly
signal a lack of progress in dealing with the long-term fiscal situation. In either case, the United
States is facing increasing budget deficits and federal debt levels over the long term.

14 Thomas L. Hungerford, “The Redistributive Effect of Selected Federal Transfer and Tax Provisions,” Public Finance
Review, vol. 38, no. 4 (July 2010), pp. 450-472.
Congressional Research Service
10

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

The Obama Administration has proposed to allow the Bush tax cuts to expire at the end of 2012
for high-income taxpayers (single taxpayers with income more than $200,000 and married
taxpayers with income more than $250,000—the richest 2% of taxpayers) and permanently
extend the tax cuts for other taxpayers (the middle-income tax cuts). The specific proposals are to
reinstate the 39.6% tax rate, reinstate the 36% tax rate for high-income taxpayers, reinstate PEP
and Pease for high-income taxpayers, and increase the long-term capital gains and qualified
dividend tax rate to 20% for high-income taxpayers. Compared with permanently extending all of
the Bush tax cuts (with more than $7,000 billion in total deficits), this proposal is projected to
increase tax revenues by $312 billion over five years and by $789 billion over 10 years (see Table
3). The 10-year reduction in estimated debt service is $140 billion. In total, this proposal could
reduce budget deficits by $931 billion over 10 years.
Some policy makers and analysts have proposed alternative income thresholds to define high-
income taxpayers. The thresholds that have frequently been discussed are $500,000 and $1
million for both single and joint taxpayers. The revenue gains (and associated debt service
reductions) from allowing the Bush tax cuts to expire for high-income taxpayers with income
over the two alternative thresholds are reported in Table 3. The estimated 10-year revenue gain
under the $500,000 income threshold is $566 billion—about 72% of the revenue gain under the
Obama Administration proposal. The estimated revenue gain falls as the income threshold rises so
that a $1 million income threshold to define high-income taxpayers is estimated to raise $401
billion over 10 years—about 51% of the revenue gain under the Obama Administration proposal.
Extending the Bush tax cuts will almost double the 10-year total deficit from CBO’s baseline
projection (the projected total deficit would be much higher if the AMT were also indexed for
inflation). These options could help reduce the total projected deficit, but only by 7% to 13%
depending on the option.

Congressional Research Service
11

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Table 3. Revenue Gain and Deficit Reduction from Expiration of Bush Tax Cuts for High-Income Taxpayers
(billions of dollars)
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2013-
2013-
2017
2022
A. Single: $200,000/Joint: $250,000
Revenue
33.9 52.1 69.2 75.5 80.8 85.9 90.1 95.5 100.7 104.1 311.6 787.8
Gain
Debt
0.3 1.3 2.8 6.3 10.6 15.0 19.6 24.3 29.1 33.8 21.3 143.1
Service
Deficit
34.2 53.4 72.0 81.8 91.4 100.9 109.7 119.8 129.8 137.9 332.9 930.9
Reduction
B. Single and Joint: $500,000
Revenue
23.8 36.1 49.9 54.5 58.3 61.9 64.8 68.7 72.4 74.9 222.7 565.5
Gain
Debt
0.2 0.9 1.9 4.5 7.6 10.7 14.0 17.4 20.9 24.3 15.1 102.4
Service
Deficit
24.0 37.0 51.8 59.0 65.9 72.6 78.8 86.1 93.3 99.2 237.8 667.9
Reduction
C. Single and Joint: $1million
Revenue
16.3 24.5 35.5 38.9 41.6 44.1 46.1 48.9 51.5 53.3 156.8 400.6
Gain
Debt
0.2 0.6 1.3 3.1 5.3 7.6 9.9 12.3 14.8 17.2 10.5 72.3
Service
Deficit
16.5 25.1 36.8 42.0 46.9 51.7 56.0 61.2 66.3 70.5 167.3 472.9
Reduction
Source: CRS estimates and calculations.
Notes: Baseline is the permanent extension of the Bush tax cuts provisions; interactions with AMT are not included in estimates.

CRS-12

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Long-Term Economic Effects of Tax Rate Increases
It is often argued that increasing tax rates will reduce consumer spending in the short term, and
work effort, saving, and investment—all key components of economic growth—in the long term.
In an underemployed economy, short-term spending increases and tax cuts—expansionary fiscal
policies—are expected to facilitate job creation, reduce unemployment, and increase output;
spending cuts and tax hikes—contractionary fiscal policies—are expected to have the opposite
effect.15 The main argument against allowing the Bush tax cuts to expire at the end of 2010 was
the weak recovery and the fear of pushing the economy back into recession, an argument likely to
be made in 2012. These short-term effects operate through the demand-side of the economy.
Some argue that tax increases reduce economic growth and kill jobs. However, once the economy
has recovered from the recession and is back to full employment, long-term economic growth is a
supply-side phenomenon and is facilitated by increasing work effort, saving, and investment.
Economic research suggests that modest tax rate increases would have little negative impact on
long-term economic growth and job creation. In the long run, the market economy naturally
generates jobs; consequently, there is little need to use fiscal policy to address job creation.16
Work Effort
For most taxpayers, the majority of income is from labor earnings or wages. Income taxes affect
after-tax incomes and after-tax wages. A rise in the tax rate will reduce after-tax wages and, it is
argued, work effort (i.e., labor supply). Economic theory suggests that the effect of earnings
changes on labor supply is ambiguous. An earnings decrease has a price effect (substitution
effect) and an income effect, which sum to the total effect. Earnings can be thought of as the price
of leisure (i.e., what is given up to increase leisure). If the price of leisure falls (due to a tax rate
increase, for example), then an individual will purchase more leisure (i.e., work less), holding
income constant. But if earnings fall then income also falls. This, by itself, leads an individual to
purchase less of all normal goods including leisure. The substitution and income effects thus work
in opposite directions. Without additional information, the total effect cannot be determined. A
large empirical literature, however, shows that men’s labor supply is insensitive to changes in
wages.17 In addition, a body of empirical work also suggests that men’s labor is insensitive to
changes in tax rates.18 Research shows that even the labor supply of high-income men is
insensitive to changes in tax rates.19
It has been argued that taxes can affect a married woman’s labor supply directly by changing her
after-tax wages and indirectly by changing her husband’s after-tax wages. Early evidence showed

15 CRS Report R41849, Can Contractionary Fiscal Policy Be Expansionary?, by Jane G. Gravelle and Thomas L.
Hungerford.
16 CRS Report R41392, Small Business and the Expiration of the 2001 Tax Rate Reductions: Economic Issues, by Jane
G. Gravelle.
17 This literature is reviewed in Mark Killingsworth, Labor Supply (Cambridge: Cambridge University Press, 1983).
18 This literature is reviewed in Jerry R. Hausman, “Taxes and Labor Supply,” in Handbook of Public Economics, eds.
Alan J. Auerbach and Martin Feldstein, vol. 1 (Amsterdam: North-Holland, 1985), pp. 213-263.
19 Robert A. Moffit and Mark O. Wilhelm, “Taxation and the Labor Supply Decisions of the Affluent,” in Does Atlas
Shrug?, ed. Joel B. Slemrod (Cambridge, MA: Harvard University Press, 2000), pp. 193-239.
Congressional Research Service
13

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

that women’s labor supply was more sensitive to wages than men’s. Recent evidence, however,
shows that married women’s labor supply after 1990 was considerably less sensitive to their own
wages and their husband’s wages than before 1990—women’s labor supply decisions were
becoming more like men’s.20
While income from labor supply may not be sensitive to taxes, taxable income may be sensitive
to tax changes. Taxpayers may be able to reduce taxable income by taking more deductions,
deferring compensation, excluding income by contributing more to individual retirement accounts
and 401(k) plans, or taking income in another form (e.g., as capital gains instead of earnings).
High-income taxpayers typically have more opportunity to respond to tax changes and reduce
taxable income through these methods.
Several studies have investigated the sensitivity of taxable income to tax rates. Most studies find
that taxable income is more responsive to tax rate changes than labor supply, though the empirical
estimates suggest that a 10% increase in tax rates could reduce taxable income by 1.2% to 4%.21
Furthermore, a reduction in taxable income may not be a complete loss to the economy or tax
revenues. If high-income taxpayers react to higher individual income tax rates by saving more in
a 401(k) plan or shifting income to the corporate form, this income will be taxed in the future (in
the case of the 401(k) plan) or taxed under the corporate income tax.
Saving and Investment
The long-run level of output depends on the amount of saving and investment. Saving and
investment increase the amount of capital in the economy and hence, aggregate supply (i.e., the
amount of goods and services available in the economy). National saving is made up of saving by
the government (public saving) and by households and firms (private saving). Public saving is
equal to the government’s deficit or surplus—it is negative for a deficit and positive for a surplus.
It is national saving that affects the long-run level of output. Many argue that increasing tax rates,
especially the tax rate on capital gains, will reduce saving and, hence, long-term economic
growth.22
Households save by investing in their own business or investing in equities, bonds, and other
financial instruments. Changing capital gains tax rates changes the after-tax rate of return on
investments (e.g., reducing the tax rate increases the after-tax return). The change in the rate of
return has two offsetting effects on saving. Increasing the rate of return can increase households’
willingness to save (the substitution effect). But at the same time, the increased return allows
households to save less to maintain their desired or target wealth level (the income effect).

20 Francine D. Blau and Lawrence M. Kahn, “Changes in the Labor Supply Behavior of Married Women: 1980-2000,”
Journal of Labor Economics, vol. 25, no. 3 (2007), pp. 393-438; and Bradley T. Heim, “The Incredible Shrinking
Elasticities: Married Female Labor Supply, 1978-2002,” Journal of Human Resources, vol. 42, no. 4 (Fall 2007), pp.
881-918.
21 See Emmanuel Saez, Joel B. Slemrod, and Seth H. Giertz, “The Elasticity of Taxable Income with Respect to
Marginal Tax Rates: A Critical Review,” Journal of Economic Literature, forthcoming available at
http://elsa.berkeley.edu/~saez/saez-slemrod-giertzJEL10final.pdf.
22 For more information on capital gains taxes, see CRS Report R40411, The Economic Effects of Capital Gains
Taxation, by Thomas L. Hungerford.
Congressional Research Service
14

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

About half of equity income is in tax-preferred savings accounts such as 401(k) pension plans and
individual retirement accounts. Additionally, capital gains are only taxed when realized, and a
substantial portion are never realized. Consequently, the effect of capital gains tax changes on
private saving is likely to be small.
The traditional economic theory of saving, the life-cycle model, assumes that individuals make
rational, far-sighted decisions. The preponderance of empirical evidence, however, does not
support the life-cycle model.23 Behavioral theories of saving emphasize the role of inertia, the
lack of self-control, and the limit of human intellectual capabilities. To cope with the complexities
involved in making saving decisions, individuals often use simple rules of thumb and develop
target levels of wealth. Once their target level of wealth is obtained, many individuals suspend
active saving.24 Saving rates have fallen over the past 30 years while the capital gains tax rate has
fallen from 28% in 1987 to 15% today (0% for taxpayers in the 10% and 15% tax brackets). This
suggests that changing capital gains tax rates have had little effect on private saving.
Capital gains tax rate increases appear to increase public saving and may have little or no effect
on private saving. Consequently, a capital gains tax increase could have a positive overall impact
on national saving.
Concluding Remarks
The 2012 debate over the fate of the Bush tax cuts is likely to take place in an almost as bleak
economic and fiscal environment as the 2010 debate over the fate of the Bush tax cuts. In the
short term, the economy is growing slowly and unemployment is likely to remain over 8.5% for
several more months. The long-term federal government fiscal situation is clearly unsustainable.
The decision over the fate of the Bush tax cuts will affect the short-term economic situation and
the long-term fiscal situation. The options will likely range from allowing all of the Bush tax cuts
to expire after 2012 to temporarily or permanently extending some or all of the Bush tax cuts. It
can be argued that permanently extending all of the Bush tax cuts could make future tax reforms
to deal with unsustainable deficits and debt trends more difficult. If the economy is still weak, a
temporary extension would not harm the economy. Furthermore, allowing the high-income tax
cuts to expire as scheduled could help reduce budget deficits in the short term without stifling the
economic recovery.25 Research has shown that tax cuts directed to high-income taxpayers have a
small stimulative effect because they tend to save any additional income.26 Increasing tax rates for
the richest 1% to 3% of taxpayers (by allowing the high-income tax cuts to expire) would likely
neither significantly decrease consumer expenditures nor adversely affect short-term job

23 For a discussion and citations to the literature see CRS Report RL33482, Saving Incentives: What May Work, What
May Not, by Thomas L. Hungerford.
24 F. Thomas Juster, Joseph P. Lupton, James P. Smith, and Frank Stafford, “The Decline in Household Saving and the
Wealth Effect,” Review of Economics and Statistics, vol. 87, no. 4 (November 2005), pp. 20-27.
25 Tax cuts to the wealthy tend to be saved rather than spent and have little impact on short-term economic growth. See
CRS Report R40104, Economic Stimulus: Issues and Policies, by Jane G. Gravelle, Thomas L. Hungerford, and Marc
Labonte.
26 See CRS Report R40104, Economic Stimulus: Issues and Policies, by Jane G. Gravelle, Thomas L. Hungerford, and
Marc Labonte.
Congressional Research Service
15

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

growth.27 Increasing taxes to reduce long-term budget deficits after the economy has recovered,
would likely have little negative impact on long-term economic growth and job creation.

27 See CRS Report R41392, Small Business and the Expiration of the 2001 Tax Rate Reductions: Economic Issues, by
Jane G. Gravelle.
Congressional Research Service
16

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Appendix. The Suits Index
The progressivity measure used is a modified Suits index. The Suits index was originally
developed to measure the progressivity of the tax burden.28 Since benefits from tax provisions are
considered, the modified Suits index is the negative of the original Suits index.
The index is based on the Lorenz curve. Figure A-1 displays the Lorenz curves for the seven tax
provisions making up the Bush tax cuts that are considered in this study. The horizontal axis is the
accumulated share of income when tax units are ranked by income from lowest to highest. The
vertical axis is the accumulated share of tax benefits from the tax provisions. The diagonal line is
the Lorenz curve for a proportionally distributed tax benefit. A progressive benefit will have its
Lorenz curve above the diagonal line (e.g., see the Lorenz curve for expanded tax credits). This
means that tax units with lower incomes receive benefits that are a larger proportion of their
income than higher income tax units. Conversely, a regressive benefit (e.g., the repeal of PEP and
Pease) will have a Lorenz curve below the diagonal line.
Let the area under the Lorenz curve be denoted as L—it is the area bounded from below by the
horizontal axis and from above by the Lorenz curve. Let the area under the diagonal line be
denoted as K. The Suits index, S, is therefore defined as:
L − K
S =
.
K

28 Daniel B. Suits, “Measurement of Tax Progressivity,” American Economic Review, vol. 67, no. 4 (September 1977),
pp. 747-752.
Congressional Research Service
17

---

.
The 2001 and 2003 Bush Tax Cuts and Deficit Reduction

Figure A-1. Lorenz Curves of Bush Tax Cut Provisions, 2012
100
Expanded tax credits
90
Reduce marriage penalty
80
70
fit
Extend 10%, 25%, and 28% tax
ene
brackets
x B
60
Ta
Extend 33% and 35% tax
rates
e of
ar
50
h
S
Reduced capital
d
gains tax rates
late
40
u
m
Reduced tax rate
on dividends
ccu
A
30
Repeal PEP and
Pease
20
10
0
0
10
20
30
40
50
60
70
80
90
100
Accumulated Share of Income

Source: CRS analysis of Tax Policy Center estimates.

Author Contact Information

Thomas L. Hungerford

Specialist in Public Finance
thungerford@crs.loc.gov, 7-6422


Congressional Research Service
18

---