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Annie Lowrey

Tax cuts served up with a side of red ink

In passing the tax compromise, President Barack Obama and his negotiators — White House budget chief Jack Lew and Treasury Secretary Tim Geithner — sneakily constructed a tax-side stimulus plan. It is big: nine digits big — as big, possibly, as the original stimulus bill. But as stimulus, it is comparatively weak.

The compromise itself can best be described as tax cuts for tax cuts (plus extended unemployment insurance benefits). Democrats would agree to a two-year extension of all the Bush tax cuts, including those on the richest Americans and on capital gains and dividend earnings. Democrats would also agree to reinstate the estate tax — though at rates that are really making them hold their noses: a $5 million exemption ($10 million for couples) and a 35 percent rate. (Liberals were hoping for something more like a $1 million exemption and a rate of 45 percent or 50 percent.)

In return, Republicans would agree to authorize extended unemployment benefits for 13 months, reduce the employee side of the payroll tax by two percentage points for a year, and re-up the Earned Income Tax Credit and Child Tax Credit expansions created in the 2009 stimulus package. They also continue an education tax credit and let companies fully expense business investment. Something neither party really needed to negotiate: fixing the alternative minimum tax, to avoid 21 million families getting hit by it.

On both sides of the ledger — taxing and spending — that amounts to a whole lot of cash. Of the proposal's estimated $700 billion to $900 billion cost, about $380 billion goes to provisions for the middle class, including tax cuts, and about $80 billion to the high-end earners. The one-year payroll tax cut costs the government approximately $120 billion. The EITC, the Child Tax Credit and American Opportunity Tax Credit (for education) take an additional $40 billion from the federal ledger. On the spending side, the big boon is for unemployment benefits, providing safety-net-level security to millions of households, most with children. The 13-month extension costs $56 billion.

All of those dollars — the tax break dollars and the spending dollars — add to the deficit, which is another way of saying that they qualify as stimulus. Congress is using its credit card — a.k.a. the world debt market — to finance spending Americans cannot afford at the moment. This might come as a surprise to anyone paying attention to the half dozen or so (it's hard to keep track) deficit-reduction plans currently in vogue in Washington.

As it turns out, everybody wants to reduce the deficit, but nobody wants to actually go about doing it. Republicans got their tax cuts. Democrats got their tax cuts, plus their spending boosts. The trade was, "You can have your deficit spending if I can have mine." That adds up to a lot of deficit spending.

But that doesn't mean it will be effective. Indeed, the package, as a whole, is not nearly as stimulative per dollar as the original Recovery Act. If you give a low-income family $1 for food via food stamps, it spends it. If you give a high-asset family $1 via a tax cut, it tends to save or invest it. Either way, the transfer costs the government $1 — nothing comes free here, or pays for itself, despite some wonky mathematicians' protestations. But $1 worth of food stamps adds more to the GDP than the tax dollar because it actually gets spent.

The most stimulative spending program in the current bill is unemployment insurance, which will put $56 billion into workers' pockets over the next 13 months, a much-needed boon for those families and a quick infusion into a demand-starved economy. The payroll tax cut is among the most stimulative tax options, leaving a bit more cash in 155 million workers' pockets.

But a whole lot of the tax changes give cash to the very wealthiest Americans and will not do much for economic growth. For instance, the estate tax will grant about $7 billion in tax cuts to the 0.14 percent of estates worth more than $5 million — money that will go to the pockets of wealthy inheritors, and will be added to the deficit, but to little to no broader economic benefit.

A lot of this money, then, will do nothing except put the country deeper into the red. That said, if the deal goes through — and the president may have trouble selling it to his own party — it will do something to aid American families, help American businesses, and soothe markets concerned about congressional intransigence and confusion over the looming tax changes.

But stimulus is not a popular word, even within the administration, and no one likes to talk about the deficit. Tax cuts, on the other hand, are almost by definition irresistible to politicians of all stripes. That is what the president is counting on as he tries to sell this don't-call-it-stimulus plan to his fellow Democrats.

© 2010 Slate

Tax cuts served up with a side of red ink 12/07/10 [Last modified: Tuesday, December 7, 2010 6:36pm]
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