Growing concern about the nation’s faltering economy largely drove President Obama and Republican leaders to reach agreement late Monday on a plan to expand the Bush-era tax cuts into a two-year, $984 billion stimulus plan that will reduce taxes for nearly every citizen and business in America.
“My first job is to make sure the economy is growing, that we’re creating jobs out there and that people who are struggling are getting some relief,” Obama said at a Tuesday afternoon White House press conference. “And if I have to choose between having a protracted political battle on the one hand, but those folks being hurt, or helping those folks and continuing to fight this political battle over the next two years, I will choose the latter.”
The deal would extend the George W. Bush administration tax breaks for families at all income levels for two years, extend emergency jobless benefits through 2011, and cut payroll taxes by 2 percentage points for every American worker through the end of next year.
While political analysts were quick to declare winners and losers in the White House negotiations, the only real losers appear to be the nation’s deficit hawks, who only last Friday reveled in what appeared to be the fiscal commission’s bipartisan consensus to reduce deficits by nearly $4 trillion over the next decade. If the Obama-GOP package passes Congress, budget balancers will see the debt grow by an additional $1 trillion, because none of the proposed tax breaks and spending will be offset by cuts in other areas.
Leading economists say that more stimulus is needed to prevent an anemic recovery from stalling entirely. The compromise plan announced Monday would achieve its stimulus through the tax code, not through additional investment in infrastructure, research and human services which is preferred by liberals.
Even Federal Reserve Board Chairman Ben Bernanke made a rare appearance on national television last weekend to warn that additional policy measures were needed after a weak showing in the private sector last month drove unemployment to 9.8 percent. “At the rate we’re going, it could be four, five years before we are back to a more normal unemployment rate,” Bernanke said on CBS’s “60 Minutes.”
While some liberal Democrats may revolt over the extended tax cuts for households earning over $250,000 for an additional two years – a clear reversal of President Obama’s pledge to hold the line on additional tax cuts for the rich – most will probably endorse the package, according to some analysts.
The compromise creates a $120 billion payroll tax holiday for people earning less than $106,800 a year; the middle class will benefit from the overall extension of the Bush tax cuts. The agreement extends unemployment benefits for the long-term unemployed for a total of 112 weeks, and it gives businesses that invest in depreciable plants, machinery and software a major new tax break, worth an estimated $146 billion in reduced corporate taxes next year.
“President Obama won policies that will put or keep money in the pockets of the families of the unemployed and middle- and low-income families, which will increase spending and create jobs,” said Lawrence Mishel, president of the left-leaning Economic Policy Institute. “That’s what a payroll tax holiday for workers, unemployment benefits and the various tax credits will do: create customers for business and create jobs, which is our biggest need right now.”
While it was largely overlooked during the Bush-era tax cut extension debate, families earning less than $88,000 a year were due to be hit with a tax increase after January 1 when the so-called “make work pay” tax credit, which was part of the president’s original stimulus package, expired. Overall, taxes for those families would rise by $60 billion a year. That clearly weighed heavily on White House negotiators.
Now, those families are slated to get a two-percentage point cut in payroll taxes, which is worth at least $400 for workers earning $20,000 a year and up to $2,136 for workers earning at the maximum amount taxed for Social Security, currently $106,800. In addition, the government will credit the Social Security trust fund for all the lost tax revenue, which means the insolvency date for the nation’s retirement program won’t be shortened by the tax holiday.
Most people earning less than $100,000 spend almost everything they earn according to economists. But whether this new tax package will succeed in lifting the economy onto a sustainable growth path is already being hotly debated.
“This is less stimulus and more a stemming of headwinds,” said Diane Swonk, chief economist at Mesirow Financial in Chicago. “At this stage, there are no silver bullets. We need all we can get to bring growth back above the economy’s potential and prevent recovery from stalling and reversing course.” She estimated the package would add an anemic 0.1 to 0.2 percentage points of growth to her forecast, which is currently at 2.7 percent for the full year. The economy needs to grow by 2.5 percent a year simply to keep unemployment from rising.
Other economists were more optimistic about the outlook. They are assuming that Congress will vote in favor of the new package before it adjourns for the year. “It’s going to provide a substantial boost to growth,” said Gus Faucher, director of macroeconomics at Moody’s Analytics, which is now projecting 4 percent growth for 2011, up from its previous forecast of 3 percent. “It will bring down the unemployment rate as well.”
Mark Zandi, chief economist for Moody’s, estimated unemployment would fall to 8.5 percent by the end of next year. That bodes well for Obama’s re-election prospects, another factor that may have weighed on White House negotiators’ minds as they made the compromises necessary to win Republican endorsement of the package.
A historical note is in order. During the last great recession at the outset of President Ronald Reagan’s first term, unemployment rose to 10.4 percent and peaked around the time of the midterm election. The following year, it fell to 8.3 percent and by election day 1984 – when his reelection advertising campaign declared it was “morning in America” – unemployment had fallen to 7.2 percent – low enough to win a landslide victory.
Still, Republican leaders reacted positively to the plan they negotiated over the last several days. Incoming House Speaker John Boehner, R-Ohio, called the proposed tax deal “encouraging,” while Senate Republican Leader Mitch McConnell cheered a package that “prevent(ed) tax hikes” and predicted a majority of his members would support it.
Beyond avoiding tax hikes on well-off households, the Republicans can take credit for reducing estate taxes. “Without action, taxes on estates over $1 million were slated in January to rise to 55 percent, where they were a decade ago. For most of the past decade, taxes on estates over $3.5 million were 45 percent. Under the proposed tax package, estate taxes will be set at 35 percent on estates over $5 million.
Some saw the fact that there was any estate tax at all as a victory for Democrats. “The estate tax is coming back, admittedly with a higher exclusion and a lower rate,” said Faucher. “But the Republicans have agreed there will be an estate tax. That’s a win for the Obama administration.”
There are other sweeteners in the package for middle-class and lower-income households. The plan extends the college tuition tax credit; expands the earned-income tax credit, which goes to the lowest-paid workers; and adjusts the alternative minimum tax so an additional 21 million households aren’t hit by the levy.
Dividends and capital gains also will continue to be taxed at a 15 percent rate, where they have been since 2003. That largely benefits households in the upper half of the income distribution.
The two-year package postpones any serious discussion about the long-term deficits facing the country until 2012, a presidential election year. That either could lead to a far-ranging debate over reforming the tax code – as proposed by several deficit reduction plans offered in the past few weeks – or another postponement of the difficult decisions that need to be made about long-term deficits. Politicians generally are unwilling to take such stands in an election year.
“If this is a two-year punt, and we come back in two years and do another punt, that’s not going to take care of the long-term problem,” said Sen. Mark Warner, D-Va., in an interview on CNBC this morning.