Economists weigh in on Obama-GOP tax deal

December 8, 2010

The always enlightening David Gitlitz of  High View Economics likes the cut of its gib:

I think you’re underestimating the impact of this deal. Sure, a “permanent” cut would be better (although there’s really no such thing as any “permanent” change in the tax code). But the thing to keep in mind is that with this package, a huge tax hike is avoided. That expected hike has been priced in the market and among businesses. That’s one big reason this recovery is so weak. So avoiding the tax hike actually amounts to a tax cut. Even if it’s only for two years, that’s still a huge relief. And who’s to say we won’t get another extension in two years, an election year? Is Obama gonna want to stand for a tax increase when he’s running for reelection? And there’s serious talk on Capitol Hill that this deal could set the stage for fundamental tax reform if the GOP takes control of both houses of Congress and the presidency in 2013. I’m bullish on this deal and what it means for the economy.

Most economists do seem to be bullish, though not always for the same reason. Brian Wesbury of First Trust:

The trade off for an extension of unemployment benefits is full-expensing on plant and equipment for coporations for at least the next two years.  We say “at least” because we think it’s likely that once enacted for two years that this part of the proposal morphs into a permanent feature of the business tax code, regardless of the election in 2012.  Trading a temporary boost in unemployment benefits (which stood no chance of being defeated) for full-expensing is a huge win for the economy.

And finally, the Social Security tax rate will be temporarily cut to 4.2% from 6.2% (for the employee, not employer).  This idea has been around for quite some time and is essentially, the “least bad” kind of Keynesian stimulus, the one least likely to do harm and most likely to support short-term growth.  For people earning above the $106,800 cap, the payroll tax cut is like a lump sum transfer of $2,136 per worker with zero change to incentives.  For most earners below the wage cap, it’s a 2 point reduction in their marginal tax rate, with a small positive effect on the incentive to work.

Some conservative politicians and analysts are complaining about the tax cut deal announced last night.  Some are even considering not supporting it.  They do not like the extension of unemployment benefits and some income tax credits (for children, etc.) that the deal proposes to make available to more people at low income levels who don’t actually pay income taxes anyhow.  This is not good policy.  However, when looked at in terms of total cost, these deals are still well worth the other improvements to policy.  In the end, the compromises are minor, not major.  The message of this deal is that “tax rates matter and lower rates are better.”

Mike Feroli of JPMorgan:

For fiscal year 2011, we are now looking for a fiscal deficit of $1.5 trillion, up from $1.2 trillion. … For fiscal year 2012, we have revised up our deficit forecast from $1.1 trillion to $1.2 trillion.

If we assume that about 2/3rds of this $120 billion [payroll tax cut] windfall gets spent that should add about 0.8%-point to consumer spending growth next year, and about 0.5%-point to GDP growth. ..  Most of the other elements of the compromise are neutral for our forecast; e.g. the income tax rates, jobless benefits, and lower-income credits are all merely a continuation of the status quo. One element that is not part of the status quo is the change in depreciation allowances to allow total expensing. As we discussed when the President first proposed this in September, we see very limited impact on capital spending. In a nutshell, our argument appealed to the fact that the experience with partial expensing over the past decade gave very little evidence that this materially affected firms’ capital spending decisions. Furthermore, the very low level of current interest rates further reduces the time value of realizing depreciation tax shields sooner rather than later.

The implied boost to growth from the increase in income and spending should lower the unemployment rate by 0.3%-pt by year-end 2011.

And here is the econ team at Goldman Sachs:

Q: What are the implications for unemployment, inflation, and Fed policy?

A: Fairly small.  On unemployment, a simple but very useful rule of thumb (Okun’s Law) is that every extra percentage point of growth should bring down the unemployment rate by roughly ½ percentage point.  Of course, there are a variety of considerations here, but the basic relationship is fairly consistent over time.  So the GDP effects discussed above would imply an improvement of perhaps ¼- ½ percentage point in the unemployment rate by end 2011.   Given this small impact on spare capacity and the time it would take to occur, the impact on inflation in 2011 would be essentially zero and likely de minimus in 2012 as well.   Other things equal, a better growth outlook would make it a closer call that the Fed extends asset purchases beyond mid-2011, and implies a slightly earlier
onset of tightening.

Q: Are you going to change your forecasts to reflect the new fiscal package?

A: Probably yes, if the bill passes in a form similar to what was revealed yesterday.  As noted above, the likely upgrade would be between ½ and 1 percentage point to 2011 real GDP growth, although this will of course depend on the final form of the bill and a number of specific assumptions about timing and spending effects.

Good reviews to from Macroeconomic Advisers:

Based upon what is currently known of these three key proposals, our preliminary analysis suggests that GDP growth in 2011 would be boosted by roughly 1/2 to 3/4 percentage point.  This is on top of the 3.7% growth of GDP anticipated for 2011 in our recently published forecast.  Growth in 2012 could also be expected to be several tenths of a percentage point higher, with modest drag on growth in 2013, as the temporary provisions expire.  This analysis assumed that interest rates were unchanged from the baseline.

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You don’t have to print the nutty Gitlitz statement so often in comments: that repetition of inane propaganda is pure Jos. Goebbels stuff. Come to think of it, Gitlitz’ doctrinaire, thought-deprived opinion is also pretty Nazi-oid. Like the other Nazis, he needs a truth squad, so here’s the non-Nazi take on it: 1- tax hike/extension didn’t do much anyway for last 10 years: wages stagnant, real growth trivial, deficit blown out since at best 1/3 of a tax cut is retrieved as taxes (and most of that thru bracket-creep). 2- speaking of creeps, Gitlitz is also wrong about pricing in tax “cuts”: biz always has an eye on taxes, but as one of the wiser commentators mentioned,it’s more about opportunity and perceived risk (as in nonimpact of accelerated depreciation schedules). 3- since “cuts” have been there for 8-10 years, they have little impact other than the dramatically huge extension of cap gains break. 4- So why does Pethokoukis bring in crackpot economists — is Gitlitz the Nazi the ringer, kinda like every village needs its idiot?

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