Tax cuts push debt to new milestone

By Jeanne Sahadi @ CNNMoney June 8, 2011

NEW YORK (CNNMoney) -- What a difference a year -- and a big tax cut -- makes.

A recent Treasury report noted that national debt will exceed the size of the economy this year -- a first since World War II. A year ago, the Treasury had estimated that notorious record wouldn't be hit until 2014.

Now the expectation is that total debt to GDP will top 102% this year, up from the earlier estimate of 96.4%.

Why the change?

Two factors are likely the biggest cause.

First, the White House's 2011 GDP estimate is $219 billion lower today than it was a year ago. So debt as percentage of a lower number will always look higher.

Second, the debt grew larger because of a tax cut deal brokered by President Obama and Republicans last December. That deal will add an estimated $858 billion to the deficits over a decade -- $410 billion of it in 2011 alone, according to the Congressional Budget Office.

Spending cuts alone won't work

The tax cut package extended all the 2001 and 2003 tax cuts for another two years, enacted a one-year Social Security tax holiday and reduced the estate tax.

Democrats and Republicans disagree on a lot, but both sides have indicated a desire to make the 2001 and 2003 tax cuts permanent for at least the majority of Americans -- a costly proposition.

And the GOP publicly says it will not consider tax increases as part of any deal to raise the debt ceiling.

Republican Dave Camp, the lead tax writer in the House, said Monday that the latest Treasury numbers are a clear indication "why any increase in the debt limit must be paired with significant spending reductions and real entitlement reforms."

But while Republicans criticize Obama for spending too much, in fact tax cuts would drive most of the debt under Obama's 2012 budget proposal, according to CBO.

That's why deficit hawks on the left and the right advocate letting the tax cuts expire or paying for any further extension. Better yet, replace them with something superior, said Maya MacGuineas, president of the Committee for a Responsible Federal Budget, who noted that this month marks the 10-year anniversary of the 2001 cuts.

"Given that our current tax code is so crummy and our fiscal situation so dire, on this 10-year anniversary, a perfect gift would be a plan to reform the tax code and bring down our debt," MacGuineas said.

At this point, the debt is so big, whether it is just below or just above GDP isn't really a huge distinction.

After examining data from dozens of countries over two centuries, economists Ken Rogoff and Carmen Reinhart found that when a nation's gross debt reaches 90% of its economy, it often loses about one percentage point of growth a year.