WASHINGTON — President Barack Obama's agreement to prolong Bush-era income tax cuts may reduce pressure on the Federal Reserve to extend its $600 billion bond-purchase program while spurring U.S. economic growth.
Obama's deal with congressional Republicans may raise gross domestic product next year by as much as half a percentage point to about 3.1 percent, said Michael Feroli, chief U.S. economist at JPMorgan Chase in New York. Tom Porcelli, a senior economist at RBC Capital Markets in New York, is raising his growth forecast for 2011 by 1 point, also to 3.1 percent.
The agreement goes beyond what economists were expecting by including a 2 percent cut in payroll taxes, which fund Social Security and Medicare. The proposal also sets the estate tax at a top rate of 35 percent, extends aid for the long-term unemployed by 13 months and would allow companies next year to deduct the full cost of investments in equipment.
"I think it does reduce the odds that the Fed does more purchases," Feroli said. "You're going to have a pretty nice increase in disposable income, and that should lift consumer spending."
The payroll tax cut would apply to all wage earners, an administration official said. That would be an $800 savings for individuals with an income of $40,000. Those who earn salaries of more than $106,800 would save a maximum of $2,136. The proposal would cost the government $120 billion, another official said.
"This is a big deal for the stock market," said Allen Sinai, chief global economist at Decision Economics in New York. The S&P 500 may rise 15 to 20 percent next year, compared with his earlier forecast for a gain of 13 to 15 percent, he said.
The tax cuts would amount to a $115 billion increase in wage and salary income, Deutsche Bank Securities economists Joseph LaVorgna, Carl Riccadonna and Brett Ryan said in a note to clients. As a result, Americans would spend $108 billion more than the three had previously forecast.
Obama said this Monday he would accept lower rates on high earners' income, dividends, capital gains and multimillion-dollar estates for the next two years to break a stalemate over extending the Bush administration's tax cuts for middle-income taxpayers before Congress adjourns. The current tax rates, enacted in 2001 and 2003, are set to increase Dec. 31.
The extension, and the economic improvement it brings, may reduce pressure on the Fed to extend its program of asset purchases beyond the $600 billion planned through June.
The tax plan takes "some of the pressure off the Fed" and means the central bank "may not need to do more," said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Mass.
Some economists said the Fed is still likely to expand its asset-purchase program. The purchases are intended to reduce long-term interest rates, making it cheaper for firms to buy new equipment or consumers to purchase houses and cars.
"I am not sure that even with the added stimulus, the Fed forecast will be where Bernanke wants it to be in June," said Roberto Perli, a managing director at International Strategy & Investment Group in Washington and a former Fed Board economist. "The new fiscal measures certainly help, but there is a probability the Fed will want to do more than $600 billion."