Why The Tax Cut Deal Isn’t Cutting It.

I want to be sold on this tax cut deal on the economics, but the more I look at it the less I’m impressed with it.

According to Ezra Klein, the White House is circulating this diagram around the Hill.  James Kwak dissects this chart and the narrative that “Obama won” on this deal; I’ll do the same.  Let’s take the “What We Got” apart.

Child Tax Credit From the Republican Pledge To America (pdf):

…these looming tax hikes will hurt every family in America. During the 1990s, a Republican Congress enacted pro-family policies such as marriage penalty relief and the child tax credit. Unless action is taken, a $3.8 trillion tax hike will go into effect on January 1, 2011 that will unravel these policies. A family of four with a household income of $50,000 a year will have to pay $2,900 more in taxes in 2011, according to a new analysis by Deloitte Tax LLP, a tax consulting firm. The same family making $100,000 a year will see its taxes rise by $4,500. In addition, the marriage penalty will return, the child tax credit will be cut in half, and the Alternative Minimum Tax will ensnare more than 25 million taxpayers.

The GOP take pride in creating and fighting for the continuation of this Child Tax Credit in their Pledge To America. It’s likely this could have been “got” without this deal.

Equipment Expensing This is unlikely to be stimulative, as per earlier research on this field. Really it just puts tax credits that are always extended informally into law. It saves lobbyists some time, but there is little reason to believe this will be very effective with demand so slack.   Would the GOP really block this?

Unemployment Insurance Huge fan.  Love to get into long discussions about the merits. This is a win. While we are at it, I also like the EITC. UI extensions are doing the major work in the estimates of GDP and employment growth in the estimates; that it is shut off after only a 13 month extension (and not extended beyond 99 weeks) puts another hostage into the ideological field of fire.

Payroll Tax Holiday I don’t see this as a huge stimulus and the more I investigate the less I’m impressed with it.  Let’s go to Mark Zandi’s estimate of the multiplier on this:

It has less than a multiplier than the “Making Work Pay” fund it replaces and doubles-down on (literally, twice as much will be spent on the payroll tax credit), virtually a one-for-one on the spending. (Most of Zandi’s results on this tax compromise are driven by the unemployment insurance.)  Compared to infrastructure spending, it’s nothing.  This will continue the weakest parts of the original ARRA, the tax cut portion, but this time weaker while branding it as the Democratic option.

This will likely pay down private debt, replacing it with public debt and doing little to rebuild the economy. And if there’s a hit to housing values in 2011, it’ll be erased completely. Getting banks to write down MBS portfolios to actual values would likely do much more.

And what is worse, Dean Baker is officially worried about how this will impact Social Security. Dean is someone I trust more than anyone on the battles around Social Security, so if he is worried I am now really worried:

The logic is that the tax cut is scheduled to expire in December of next year. While it would require new legislation to extend the cuts, the Republicans will describe the failure to extend the cuts as a tax increase on middle class workers…Democratic officeholders have had difficulty standing behind tax increases for the very richest people in the country. It is difficult to imagine them sticking their necks out for tax increases that will hit low and middle-income workers, especially in a context where unemployment is virtually certain to be above 8.0 percent and quite likely above 9.0 percent. This means that the reduction in Social Security taxes may not be for just one year, it may persist for the indefinite future…

Unfortunately, the Obama administration cannot be counted on to defend the program either…In short, supporters of Social Security have good reason to oppose the tax deal. It is easy to have the same stimulus with an expanded version of President Obama’s Making Work Pay tax cut. Supporters of Social Security should reject the latest deal and tell President Obama to stand behind his own tax cut. This is what presidents are supposed to do.

(Read it all.)  Mark Thoma also made this observation as soon as the deal was announced. Also this compromise manages to raise taxes on many while keeping them low at the top.

I don’t find these extra “gots” particularly credible as stimulus, and I’ve become less impressed as the week has gone on and I discuss it with more people.   If we can get the tax cuts for 2 years on the $250,000 and below and the UI extensions, why not take it and go home?   Are we certain we can’t get it without fighting for it, especially now that we know what the stakes are?

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22 Responses to Why The Tax Cut Deal Isn’t Cutting It.

  1. Ken Houghton says:

    Good to see Ezra is still fellating Joe Biden. If “we” got the Payroll Tax holiday, then I feel like The Lone Ranger with Ezra asTonto.

    Make Work Pay: mostly subsidies for those making <$40K (just below hhold mean).Payroll tax holiday: $106K+ benefits the most–not to mention employers who will not (no matter what Sensible Centrist Economists say) pass their portion of the cut on to workers. So unless firms are across-the-board hiring 1% more people, it's going to go to corporate profits, not job creation.

    And that would be ignoring that having Kent "my constituents are too stupid to know I screw them regularly" Conrad and Paul "the budget fairy will keep everything balanced: Ryan running budgets is like letting the Beagle Boys guard Scrooge McDuck's safe.

  2. Andy Harless says:

    The other thing “we” get, though, is the original middle class tax cuts. Those were a logical prerequisite for the upper class cuts, so the Republicans had to accept them as part of the package, but they were what Obama wanted originally, and they were by far the most costly feature of the ultimate plan. Frankly, it seemed pretty dumb all along to be making such a big deal about $700B while insisting on a $2T budget-buster. But given the weakness of the recovery, it seems insane not to extend the middle class tax cuts for at least a few years (except in a very unrealistic world where you get to replace them with a better stimulus, of which there are many, but none of which would be even remotely acceptable to the Senator #60 as a replacement).

    What’s more, the Republicans would gain a political advantage by killing the hostage, because the economic impact would significantly reduce Obama’s reelection chances, whereas over 2 years, people would forget that it was the Republicans’ fault. In my view, even an unconditional surrender would have been a de facto win for Obama. He gets 3 times as much middle class tax cuts as the Republicans get upper class cuts, and he probably gets reelected. Everything else is just gravy and saving face. And it still looks to me like a hell of a lot of gravy. It turns out not to have been as good a face save as I would have thought given the amount of gravy involved, but I’m inclined to judge things on the merits rather than on the symbolism.

    While the overall package doesn’t give as much “bang for the buck” as one might hope, it has enough bucks in it that it gives more total “bang” than anyone expected. Leaving partisan issues aside, as someone who wishes to avoid a Japanese-style lost decade (or worse) for the US, I continue to support this plan enthusiastically, especially given that the alternative now seems to be no stimulus at all — which, relative to the significant stimulus we have been getting from the Bush tax cuts and what remains of ARRA, would be a major hit to aggregate demand.

    I don’t buy the argument that this will weaken Social Security. The trust fund is not being reduced, and the tax cuts are explicitly temporary. Yes, they may be (and should be!) extended for one or several years. But to make them permanent would be such an obvious abuse of the Social Security System (or the federal budget, depending on how you look at it) that it couldn’t possibly be acceptable.

    Also, assuming that some significant economic recovery happens over the next 2 years, I don’t see how a compromise further extending the Bush cuts can ever be reached. Without the critical need for a stimulus, as we are currently experiencing, the Democrats will have no incentive to accept a compromise (especially after the heat Obama has taken this time), and there really is no compromise that would satisfy the Republicans.

  3. Mike says:

    Thanks for commenting guys.

    Andy,

    Big fan of your blog. That does seem to be the debate – this versus nothing, and nothing also meaning no middle-class tax cuts. Are there skeptics on how bad losing the middle-class tax cuts would be? I’ve only seen Krugman in his column last week. From what I’ve seen I think its Pretty bad more than slightly bad to yank that right at this moment, akin to the 1937 balancing budget move, though I want to see more.

    This post is more about the new package as a whole and the payroll cut specifically. The payroll tax cut strikes me as replacing private debt with public debt, particularly bad housing debt. That may or may not be the worst thing, but i think there could be better measures and if housing takes a dip next year that won’t matter much at all. I think this is a bad sell as stimulus 2.0 and better thought of as “don’t pull the rug out on stimulus 1.0.”. Or better, if we could get the < $250K tax cuts and UI we get virtually everything that is good a out this compromise deal, which is what people were pushing for in the first place.

  4. rjs says:

    there’s less than a million of “theys”

    the rest of us have to divide that “we” pot…

  5. denim says:

    The payroll tax cut is intended as a death blow to the future solvency of social security. Bernie Sanders says it will be politically easy to make it permanent. There is absolutely nothing that the republicans could do to get me to settle for putting that on the table.
    In 2012, it will not matter if Obama is on the presidential ticket. Because of this outrage, I will write in the Name: Bernie Sanders, period.

  6. roger says:

    “What’s more, the Republicans would gain a political advantage by killing the hostage, because the economic impact would significantly reduce Obama’s reelection chances, whereas over 2 years, people would forget that it was the Republicans’ fault.”

    This is the (insane) narrative driving the Obama-ites, and has been for a long time. Republicans have magic power! People will forget how bad the Republicans are!

    Actually, Obama was elected on a wave that showed the exact opposite. And he has operated, since then, as though this were an accident and the Republicans are the ‘natural governors.”

    There is a Pavlovian element in life. Pain can produced servility. But pain also produces the desire for revenge. It is very very unlikely that the people will ‘forget’ that the republicans voted down the unemployment extension – but they will never get a chance to remember or forget, as Obama caved to the Reps to get it. Politics on this scale of timidity is a loser, and only leads to bigger and bigger losses. It is also puzzlingly childish – it is the mindset of the beat up child on the playground. It is certainly not grounded in polls, or in history of any type.

    However, in D.C., where the powerful circles are white, male and rich, it is true that the people – the people in the country club – seem to ‘forget’ all the good things Obama does. This shows the utter disconnect between political thinking – which is about favors – and business thinking – which is about profits. Obama has been excellent for rich people. But rich people, funnily enough, want to get richer. They have no gratitude whatsoever for favors, and they press the richer button whenever they can. Thus, they will, for instance, use some of the extra money they got through Obama’s policies and – set up GOP re-election committees. Why? Cause there’s no downside. The Obama-ites will interpret this as some kind of mass nightmare that brings up their playground fears (the people are so ungrateful!) and cave, or, on the other hand, they will manage the election of people who promise to make them even richer. True, they could go oopsy in the race for de-regulated money, but then they can depend on the Obama-ites to make it all better for them.

    This deal is based, on the Dem side, on baseless fear, and on the Rep side, on baseless triumphalism. It stinks, and the Dems would do well for themselves and even for the clueless president in rejecting it. Then lets test the proposition that the people will get so confused about who is blocking unemployment extensions that they will blow up the white house.

    Clinton figured out, after 1995, that he had nothing to be afraid of. Obama, on the other hand, doesn’t have a clue.

  7. roger says:

    Oops, this part of my third to last paragraph may seem confusing…”they will manage” – this could be clearer. The “rich people” will manage

  8. Kaustabh Duorah says:

    Andy, I am missing something here. The middle class tax cuts is nothing more than what we have at this moment. So its no added stimulus. Looking at the current situation, I dont see that it will help in improving the economy. More like it will stop it from going down. So too is the UI. The plus is the FICA cuts, which will negate the MWP cut for some people. So in terms of stimulus, I dont see any added boost to the economy. So, are we going to muddle through the next year, or will unemployment go back to 5%? My guess is the former, which is not good for Obama, the democratic party or any of us.

    Re SS, I am cynical enough of the GOP, Fox news, democratic party and the news cycle to believe that it can be easily spun in the GOP’s favor. My feeling is your optimism is misplaced. A lot of things have happened in the last decade that I would have thought impossible earlier.

  9. K. Williams says:

    “If we can get the tax cuts for 2 years on the $250,000 and below and the UI extensions, why not take it and go home? Are we certain we can’t get it without fighting for it, especially now that we know what the stakes are?”

    I don’t understand what you’re asking here. Do you mean “can we cut taxes only on the $250K and below and UI extensions, while letting the tax cuts on the rich expire?” If that’s what you’re asking, why even ask it? We are certain we can’t get it. There is no way the Republicans will let any bill that doesn’t cut taxes for the rich come to the floor, and if Democrats insist on killing this compromise, the Republicans will just wait until January and pass all the tax cuts, without the UI extensions or anything else. It’s this or nothing. If you think we should take nothing, then say so. But there’s no point in idly speculating about what “fighting for it” might get the Dems. The Republicans just won a a massive electoral victory. They have no interest in helping the unemployed, and their single biggest commitment is to not letting taxes go up on anyone. The fact that Obama got as much as he did is, in fact, a good thing.

  10. Pingback: Obama’s Tax Deal, in links « zunguzungu

  11. urban legend says:

    Dems vs. Republicans is murky. Try wealthy vs. average Americans. Some rough math: the top 1% got $114 billion of this so-called stimulus, the remaining 99% got $238 billion. The average recipient per capita in the top 1% got $38,000 in total value, or about $3200 per month. The average ordinary American got less than $800, or about $65 per month.

  12. Kumar says:

    I’d be interested in seeing what other parts of ARRA are falling off in 2011, e.g. some infrastructure spending and aid to state and local governments. Is the new package sufficient to offset those declines?

  13. wjd123 says:

    The weaker the economic considerations get against this proposal the the stronger political considerations get against it.

    When I first heard of this compromise I didn’t see how those in the Democratic Party calling for more stimulus could pass it up. Emotionally I hated the compromise, but I did my best to put my feelings about hostage taking aside and ask what was best for the country.

    I tried to compare apples to apples. For instance the harm done to the lives of the unemployed if the compromise didn’t pass against the potential harm done to people on Social Security if the compromise did pass. It’s doubtful how successful I was in keeping an open mind. I’m on Social Security and I fear either party mucking around with it. I have an emotional bias. I’m more open to reasonable arguments against payroll tax credit than for it.

    The same applies to economic arguments against the bill. This essay does offer a economic reason for not passing the compromise: the stimulus isn’t as great as advertised. But most of the reasons against it are about political strategy: the Republicans aren’t going to hold this or that provision hostage so there was no reason to give up anything to have them put in the compromise. The straight political argument advanced was on Social Security: it’s dangerous to muck around with it. There is also a psychological argument against paying for Social Security out of general funds: it takes away pride of personal ownership.

    On the one hand we end up on the strategic front with legitimate reasons against the compromise, and on the other hand we end up with Obama’s word that it was the best deal that could be gotten. But we will never know since he did his negotiations in secret.

    Although it was never mentioned there is a huge political argument on why the liberal wing of the Democratic Party has to get Obama to renegotiate the compromise: if they can’t they will become irrelevant for the next two years while Obama triangulates. In two years no one will know what the Democratic Party stands for. It will be perceived as the party of republican lite.

    Obama says that there are issues down the road he will fight over. What issues? He’s a conciliator not a fighter. If he can’t fight against giving tax breaks to the rich where the winds of public opinion are at his back why should liberals believe he will fight when the winds are against him.

    If liberals don’t take on Obama on this question they will be seen as a captured wing of the Democratic Party that always gets rolled. Obama will have taken it hostage.

    • wjd123 says:

      ” He’s a conciliator not a fighter,” should read, “He is a political conciliator not a fighter.” I believe that in his role as Commander-in-Chief he’s a warrior but not when it comes to politics.

  14. Neildsmith says:

    The problem with all these deals is that they perpetuate the idea that we can “fix” the economy by Congressional tinkering with tax rates/deductions/credit/incentives etc. By playing this game, we enable corruption on a grand scale. I guess that’s just the way if will forever be. We’ve been talking for decades about the need to simplify the tax code and yet every “deal” is just another gimmick. Frankly, I can’t see how any of this matters except at the margins.

    Thanks to all for the tax cuts, but I’m still not buying an overpriced house. You all are on your own.

  15. There was an older version of that Fiscal Multipliers chart that was reprinted in the 1st edition of Krugman and Well’s textbook that had a line like this:

    reducing the estate tax: 0.00

  16. NKlein1553 says:

    Completely unrelated to this post, but I wonder Mike if you wouldn’t mind commenting on this article in the New York Times today:

    http://www.nytimes.com/2010/12/12/business/12advantage.html?_r=1&adxnnl=1&partner=rss&emc=rss&pagewanted=1&adxnnlx=1292173202-L+YrQq0MK2d4QyDToGl/yQ

    The article reminds me of the debate you had with Economics of Contempt over the Lynch Amendment last winter. EoC claimed collusion among the big banks wouldn’t be a problem for the clearinghouses that would be set up and exchange-trading requirements weren’t the answer. Well, it seems collusion is a bigger problem than he thought.

  17. Pingback: The Good, The Bad and The Ugly Of Compromise Stimulus « Chasing Fat Tails

  18. Andy Harless says:

    Roger: “People will forget how bad the Republicans are!…Actually, Obama was elected on a wave that showed the exact opposite”

    Are you kidding? Obama was elected when the economy was tumbling off a cliff. Given that people tend to blame the party holding the presidency, “how bad the Republican’s are” was right in everyone’s face.

    History shows that people do forget. They hated Nixon in 1970, Reagan in 1982, and Clinton in 1994, but they loved them when election time came two years later. But they hated Carter in 1980 and Bush 41 in 1992 because there were recessions. You’re crazy if you think people will blame the Republicans if the economy is still in its current condition two years from now. Without a recovery, Obama doesn’t have a chance. And without some ongoing fiscal stimulus, the recovery doesn’t have a chance.

    Kaustabh Duorah,

    Most forecasters are expecting the economy to start recovering more quickly on its own over the next couple of years, but those forecasts assume that the middle class tax cut extensions will be passed. The compromise package contains significantly more fiscal stimulus than most forecasters were assuming, although not more than we are experiencing right now. It’s not a question of “added boost” to the economy but of how strong the drag will be against the natural recovery process. With no deal at all, there will be a huge drag. With just middle class tax cuts, there would be a moderate drag. With the proposed package, there will be only a slight drag. Nobody expects 5% unemployment in 2012, but at 8% Obama has a shot. At 10% the Republican primary will be the presidential election.

    Mike,

    I don’t understand what you’re saying about a downturn in housing making the payroll cut ineffective. It could offset the effect of the payroll cut, but the outcome with the payroll cut would still be better than the outcome without it. Admittedly it would raise interest rates and contribute to the weakness in housing, but surely the net effect would still be positive. If anything, I would think, given a downturn in housing, that liquidity constraints would be particularly binding and therefore such temporary tax cuts particularly effective. Replacing private debt with public debt is the whole point, when you’re trying to combat a balance sheet recession.

    And see my response to Kaustabh Duorah above w.r.t. not pulling the rug out on stimulus 1.0. I don’t care how you number them, but if you have a stimulus, the rug automatically gets pulled out unless you have another stimulus. The hope is generally that the underlying growth of the economy will be strong enough to outweigh that rug-pulling (pardon my mixed metaphor), but in this case that seems unlikely, so pulling the rug would be a bad idea.

  19. Bernard says:

    if the Republicans are going to restore the tax cuts to the Rich when they get in power come January, Obama is stupid to give away anything. Obama’s not getting anything worth dealing with the Republicans anyway. the Republicans aim to destroy Obama. I can see why. Obama is a worthless piece of ….

    touching Social Security is the only reason the Republicans want this deal now. the Republicans would pay dearly if they “touched” Social Security. Getting Obama to do their dirty work would be their dream come true. which is why gutting Social Security starts with this tax deal.

    Trust Obama or the Republicans to steal what they can. that is their nature. lol
    to expect otherwise is plain stupidity.

  20. Pingback: Why The Tax Cut Deal Isn’t Cutting It. (via Rortybomb) « Pilant's Business Ethics Blog

  21. wjd123 says:

    This from David Cay Johnston:

    AMY GOODMAN: Well, David Cay Johnston, talk about the legislation that the Senate is poised to pass today.

    DAVID CAY JOHNSTON: Well, you certainly cannot accuse the Republicans of leaving any money on the table. They got an extraordinarily good deal, that raises, I think, basic questions about the negotiating skills of the President. The bottom roughly 45 million families in America or households in America—and there are a little over 100 million households—they’re going to actually see their taxes go up. And that’s because President Obama’s Making Work Pay credit—$400 per person, $200 for a couple, and you got it even if you were retired or disabled—is going to go away. And it’s going to be replaced by this temporary two percent reduction in the payroll tax, the Social Security tax. Well, for about 45 million households who make less than $20,000 a year, this is a tax increase of $150 to $200 each. So, it certainly seems to me it’s reasonable going forward, given how the Republicans have emphasized they will never raise taxes on anyone and they are the party of tax cuts, that the Republicans have now become the party of tax increases on the poor.

    At the top end, if you’re a two-income couple and you make a little over $100,000 each, so you pay the most Social Security tax, you didn’t get Obama’s Making Work Pay credit. You were regarded as too well off. But that Social Security payroll tax decrease is going to mean about a $4,200 tax cut for you. So, clearly, we could see the scheme of this is: the better off you are, the more help you get from the government; the worse off you are, your taxes go up.

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