James Pethokoukis

The news just gets worse and worse from my home state (via The Tax Foundation):

llinois’ legislature is currently considering an alternative to the initial tax increase proposed last week. Instead of pushing for a 75% increase in the personal income tax and a 49% increase corporate income tax, this proposal would raise the individual income tax rate to 5% and the corporate rate 9.5%. While this proposal is more modest than the first, but it still hurts the competitiveness of Illinois when it comes to maintaining and attracting new business.

If this passes, Illinois will have the third highest corporate income tax in the country behind only Minnesota and Pennsylvania. The corporate income tax has been shown to be among most damaging tax in terms of economic growth.

The individual income tax is often times ignored as a factor in business decisions. This is unfortunate because a large amount of business income is actually filed through the individual income tax. In raising the rate to 5%, Illinois would have the one of the highest flat individual income tax in the country.

In solving their budget problems, Illinois needs to do something that it has not done in a long time and that is look to the future. The governor and the legislature need to look past the next day, week and month and consider the long term effect of their policy decisions.

It looks like Robert Gibbs will be leaving the White House to run his own consultancy and work on Obama’s 2012 campaign. Ruy Teixeira, a politics guys not an econ guy, thinks the Obama-Republican tax deal makes it far more likely that campaign will be a successful one:

A significantly better economy is certainly the key to reaching voters in the white working class, which supported House Republicans by an unprecedented 30 points in 2010. To be reelected, Obama needs to bring that gap down to around its size in 2008 (18 points), and he simply won’t get there if these voters, unsympathetic to Obama to begin with, continue to see a lack of economic progress.

That much may seem obvious. But, in addition, it’s also true that Obama’s performance among sympathetic constituencies will depend to a very great degree on the economy. … The fact is that tens of millions of ordinary rank-and-file Obama supporters will end up basing their decisions on the state of their pocketbooks and the job market: Want 18-to-29-year-olds to turn out as 18 percent of the electorate and support Obama by anything like the 66-32 margin of 2008? Want minorities to turn out as 28 percent of the electorate and vote for Obama by a margin of 80-18? Want moderates to turn out as 44 percent of the electorate and support Obama by a margin of 60-39? Numbers near these will be impossible to achieve if the economy continues to stumble. Conversely, if a recovery seems to be kicking in, confidence will rise in Obama and his agenda, making it more likely that these voters will turn out and back the president.

It’s as simple as that. And Obama’s $858 billion package of tax cuts, tax credits, and unemployment benefits will in effect deliver a second economic stimulus, albeit not one any progressive—or sane—economist would have dreamed up on their own. In a world where unemployment barely budged and GDP growth couldn’t get above 3 percent, Obama’s re-election would be in considerable doubt. But with the tax-cut deal, there should be a significant decline in unemployment (though the absolute level will remain high) and a more robust growth rate, including during quarters two and three of election year, which political scientists tell us is particularly important to electoral outcomes.

If 3 percent growth and 9.5 percent unemployment is inadequate, will 4 percent growth with 8.5 percent unemployment be good enough? That, along with a lousy housing market and high national debt which makes the future especially worrisome? I have written repeatedly that there is a lag between when an economy improves on paper and when voters recognize improvements in their own standards of living. Just as the Bush (I) campaign team in 1992.

– The author is a Reuters Breakingviews columnist. The opinions expressed are his own –

Barack Obama looked like the walking dead after his party’s midterm wipeout.  But he revived during the lame-duck Congress and closed important deals on trade, taxes and arms control. The president will need the rest this holiday season should bring, however. His “to do” list remains hearty and lengthy. The following are some of the 2011 biggies that will require the head of steam he built up this year-end.

The budget. The numbers aren’t getting any better. Federal scorekeepers had been forecasting a 2011 gap of $1.1 trillion, or 7 percent of GDP. But the $858 billion stimulus package over three years could boost those totals to $1.4 trillion and 9.5 percent. And that’s running the books on a cash-in, cash-out basis more befitting a hot-dog stand than an economic superpower. Corporate-style accrual accounting methods, which factor in future pension and healthcare costs, show 2010 liabilities exceeded assets by $13.5 trillion, according to a new Treasury Department report.

Obama’s debt commission reported in early December, but its creator has yet to say which elements he supports. That time is coming. A bipartisan group of senators will introduce the panel’s recommendations early next year.

Taxes. There’s precious little time for back-slapping on the successful extension of the Bush-era tax cuts. A good chunk of America’s tax architecture is due to expire in two years. But the code’s temporary nature may not be its worst feature. U.S. individual income and corporate taxes will raise about $1.1 trillion in revenue this year. The debt panel has identified about $1.1 trillion in revenue-losing tax breaks. If Obama wants to get rid of these myriad holes, raise revenue and cut rates, Republicans may play ball.

Trade. Now that Washington and Seoul have tweaked their deal, the U.S.-Korea trade agreement should easily pass Congress. But the White House is showing little interest in submitting treaties with Colombia and Panama for legislative approval. To boost exports and reward U.S. allies, Obama should persuade or ignore his union backers and send the pacts to Capitol Hill.

Even if the president can somehow strike all those important items from his list, there will still be a host of battles to be waged over financial, healthcare and energy regulation. And before Obama knows it, campaign season will be here.

Well, that was quick. America’s supposed generational shift toward an embrace of high-tax, high-service Big Government didn’t even make it a full two years. The new public policy consensus — built around favorite liberal issues of the environment and income inequality — promoted by Washington elites has been a flop with the public.

The nation’s ruling class thought for sure the financial crisis and subsequent Great Recession would create so much economic insecurity that it would be easy to pass a broad expansion of the welfare state — all financed by a combination of higher income taxes on the rich and new energy taxes on the middle class.

Instead, concerns about the federal budget deficit and competition with China became paramount. And the liberal agenda of healthcare reform and cap-and-trade suddenly seemed terribly off-point. So within a span of seven weeks, Democrats lost control of the House and then their legislative agenda.

First, the $858 billion tax deal. The near-term economic impact may modest. Some $500 billion of that total is merely the “cost” — as government bean counters look at things — of extending current income tax policy. Consumers will save most of the payroll tax cut, while extending the funding of unemployment insurance will make unemployment a bit higher than it would otherwise be.

But longer-term, the package is extremely bullish. It shows clearly that the “battlespace” of the coming Republican-Democrat fiscal clash will almost entirely be on the spending side of the ledger. There is little appetite among the public for sending more tax dollars to a wasteful and inefficient Washington. And the debate over restructuring the U.S. healthcare system will be between trusting government rationing or trusting market efficiency and choice.

The failure to pass a 2011 budget is also tremendously positive. It shows the impact of the Tea Party movement has not waned since the November midterms. This creates a situation next year where the flood of new Tea Party Republicans can combine a threat of government shutdown with a refusal to raise the national debt ceiling so as to squeeze spending cuts out of Obama and congressional Democrats.

Indeed, some GOP insiders believe the president — with a bit of nudging — may be ready to strike a deal to reform the tax system and cut future Social Security benefits along lines suggested by his own debt commission earlier this month. And as the tax compromise shows, Obama now seems willing to anger some within his own party in order to get legislation passed and win the reelection.

But if Obama does manage to somehow eke out a second term, it will be as president of a country that he may understand a bit better than he did two years ago. His true value and concerns in 2008, it turns out, were not those of most of his countrymen. Most Americans were not itching for government-run healthcare, a vast energy bureaucracy, an expansion of union power or new penalties on success and wealth creation. To a great extent, the term Tea Party America is redundant. The U.S. remains a center-right nation, and prosperity usually ensues when its leaders understand this.

Overall, a pretty good day for those who believe in low taxes and less spending. Here is the money graph from my upcoming Reuters Breakingviews column:

Democrats and Republicans in Congress are gridlocked over the $1.1 trillion 2011 budget. So they will likely pass a temporary spending measure to keep the government running for another month or two. This creates a situation next year where incoming Tea Party Republicans can a) combine a threat of government shutdown with b) a refusal to raise the national debt ceiling to c) squeeze deep spending cuts from Obama and congressional Democrats. Indeed, some GOP insiders believe the president —  with a bit of nudging — may be ready to strike a deal on tax reform and cutting future Social Security benefits along lines suggested by his own debt commission earlier this month. And as the tax compromise shows, Obama is now seems more than willing to anger liberals within his own party and scuttle past campaign promises to get legislation passed.

Of course, the biggie is healthcare and that is going to have to be settle by voters in 2012.  But what a change from January 2009 when Obama’s election was supposed to signify a generational political swing toward more activist government.

Over at NRO, Duncan Currie gives it his best shot:

Despite being more efficient than an ordinary sales tax, a VAT carries significant administrative costs, and piling it on top of the present U.S. tax structure would be a mistake. But using the VAT to eliminate a sizable amount of distortionary U.S. income taxes would yield a far more growth-friendly system than the one we have today. Over the long run, America must reorient its economy away from consumption and toward investment while boosting its dangerously low savings rate. A VAT is certainly not the only way to promote those objectives, but it should at least be part of the conversation.

In the piece,  Currie more or less outlines a proposal similar to what Gov. Mitch Daniels suggest a month or so ago: Lower existing taxes rates and add a VAT.  I don’t believe he means for this to be a tax increase. Higher government revenue would come from higher economic growth.  Of course, many liberals see a VAT as an efficient way to dramatically raise taxes. Roger Altman, perhaps the replacement for Larry Summers in the White House, has recommended a $500 billion VAT.

In theory, I don’t have a problem with the Currie-Daniels approach, though I would prefer to have the income tax repealed. I also don’t think it would automatically lead to higher and VAT taxes and higher and higher spending — especially not after reading this piece. As Currie notes:

Moreover, while the VAT can lead to higher spending, it does not inevitably have that effect. Consider what happened in Canada, where the Progressive Conservative government of Brian Mulroney implemented a federal VAT in 1991. Since then, as economists William Gale and Benjamin Harris of the Urban-Brookings Tax Policy Center point out, “the size of the Canadian federal government has shrunk significantly.” The VAT rate started at 7 percent, but it has fallen to 5 percent under the Conservative government of Prime Minister Stephen Harper, which has also slashed corporate taxes.

In New Zealand, it was a neoliberal Labour government that embraced the controversial consumption tax. During the mid-1980s, Prime Minister David Lange and his finance chief, Roger Douglas, spearheaded a radical program of fiscal consolidation that included massive income-tax reductions, deep spending cuts, ambitious deregulation, and a 10 percent VAT.

Things may be going swimmingly in the US Senate, but not so the House:

WASHINGTON (Reuters) -House of Representatives Speaker Nancy Pelosi will not bring President Barack Obama’s current proposed tax plan up for a vote in her chamber, an aide said on Thursday.

The aide said Pelosi would require changes be made to the measure that most of her fellow House Democrats formally opposed by approving a resolution of opposition to it. The aide said: “She (Pelosi) will honor the resolution.”

It’s simple: If the Bush tax cuts are not extended, the US risks falling back into recession next year. At the very least, the markets believe that and will act accordingly. Not to mention what a disaster this would be for the Obama presidency:

The obvious lesson, if the deal collapses, will be that Obama can’t deliver anything – he can be pushed into compromise with GOP priorities, as he wouldn’t before the election, but he can’t bring along his own caucus, which has suffered so many losses for following his lead. Liberals will learn that they are better off striking their own distance from an unpopular and increasingly impotent leader. And heavy liberal opposition to the deal will make it impossible to blame DeMint or Republicans for the collapse, and will encourage conservatives to push for even fewer compromises with Obama in 2011. That calculus of legislative forces will make it hard for Obama to plan for the other leg of the Clinton strategy, a budget battle in which the GOP blinks. Obama can try to use the whole mess to argue that “Washington is broken” and all that, but it’s a hard argument to make from the Rose Garden.

By failing to ensure ahead of time the support of his own caucus, President Obama may have shot himself in the foot in dealing with the Republican-controlled House even before the new majority is sworn in.

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.

OK, I’ve already laid out the expanded Jim DeMint argument for voting against the Obama-GOP tax compromise.  So how does the GOP leadership see things? If I was John Boehner or Paul Ryan or Eric Cantor or some other top GOPer,  I might counter with something like this:

Jimmy P.,

Your column appears to start from a false premise that this is the Republican stimulus package.  Who is arguing that? We are arguing for a prevention of tax increases, which is what we have the opportunity to do while Pelosi, Reid and Obama still run Washington after running against the very Bush tax cuts they are set to extend.

We will have far more power when the next Congress is sworn in — at which point we can take more significant steps to advance a pro-growth agenda.  It is fine to make comments publicly about preference for permanence, but it is difficult to see the upside in playing chicken as the clock keeps ticking toward New Year’s Day.  It is difficult to imagine a better bill that will need the support of Nancy Pelosi and Harry Reid — and signed by President Obama — all before across-the-board tax hikes hit on January 1.  Obama has already done tremendous damage to his tax-and-spend policy preferences, and he continues to inflict more damage to his credibility with his bizarre press push (his hostile hostage logic is beyond twisted and the tired class warfare rhetoric beyond flat).

We are not advancing temporary sugar-high economics as our own stimulus package. we’re making the case against further economic damage from this Congress and this Administration.

Do I buy this? I dunno about the politics but the clock is definitely ticking. It is key that the Bush tax cuts get extended. But I also think it is important that supporters of pro-growth tax cuts make it clear which parts of the package are helpful and which are not. All tax cuts are not alike. Some are better than others. Clarity is required.

For many conservatives, the thumbs-up from Rep. Paul Ryan of Wisconsin is reason enough to support the Obama-GOP tax deal — well, that and the fact so many liberals are in a purple rage about it. And certainly there is nothing wrong about letting individuals and businesses keep more of their money — even for a little while. But Sen. Jim DeMint of South Carolina, another lover of tax cuts and hater of bloated big government, says he will oppose  and even filibuster the ginormous stimulus package. Here is DeMint on the Hugh Hewitt radio show:

I’m glad the President recognizes that tax increases hurt the economy. I mean, I guess that’s progress. But frankly, Hugh, most of us who ran this election said we were not going to vote for anything that increased the deficit. This does. It raises taxes, it raises the death tax. I don’t think we needed to negotiate that aspect of this thing away. I don’t think we need to extend unemployment any further without paying for it, and without making some modifications such as turning it into a loan at some point. It then encourages people to go back to work. So there’s a lot of problems with it. I mean, and frankly, the biggest problem I have, Hugh, is we don’t need a temporary economy, which means we don’t need a temporary tax rate. A permanent extension of our current tax rates would allow businesses to plan five and ten years in advance, and that’s how you build an economy.

DeMint might have a point, several actually – and the implications are huge. The perceived failure of the 2009 Obama stimulus plan has again discredited the idea that government can spend America back into prosperity. But liberals, including many in the White House, protest that conclusion. They argue that the $900 billion package was both clumsily designed and too small given the depth of the Great Recession. But sorry big spenders, you only get one chance to fire a trillion-dollar bullet.

Of course, Republicans may find themselves in the same position if the $900 billion (mostly) tax-cut plan fails to reignite job growth in 2011 and 2012. Oh, the folks with the Keynesian demand-side, static analysis economic models say not to worry.  Wall Street firms such as Deutsche Bank, Goldman Sachs and JPMorgan — as well as the Congressional Budget Office —  think a) extending the Bush tax cuts, b) cutting payroll taxes, c) allowing business to immediately expense investment and d) funding more unemployment insurance will add as much as a percentage point to GDP growth next year and reduce the unemployment rate by around a third of a percentage point.

But if this new trillion dollar bullet doesn’t work as promised, the power of the tax-cut message would be greatly undermined.  And there is good reason to think the results will be disappointing:

1. DeMint thinks America needs a “permanent economy,” not a temporary one. Milton Friedman would agree. Uncle Miltie’s Permanent Income Hypothesis says short-term changes income don’t change spending habits, changes in long-term expectations do. PIH has been backed up by numerous studies (such as here and here and here) and argues for permanent tax cuts, not ephemeral ones.

2. The much-hyped payroll tax cut is not a supply-side cut. The Institute for Policy Innovation nails it:

One of the proposed provisions in the deal to extend the Bush tax cuts is a temporary 2 percentage-point reduction in the Social Security payroll tax, from 6.2 percent to 4.2 percent. Tax cuts that stimulate real economic growth operate at the margins–affecting an additional dollar of income, or an additional dollar of savings and investment–not the first dollar of income. Supply-side tax cuts encourage additional production by stimulating additional work, saving and investment.

A payroll tax cut is not a supply-side cut and won’t have much impact on economic growth. Rather, it embraces the Keynesian idea that the economy is stimulated by putting a few hundred dollars in people’s pockets so they can consume more.  … If there has to be a payroll tax cut, it actually makes more economic sense to give it to the employer half of the payroll taxes than to the employee. That would at least mitigate some of the risks of hiring new employees that have been imposed by Obama administration policies.

3. All of these temporary tax cuts will do little to lower policy uncertain among business and investors. There is still plenty of reason to worry about taxes and spending in the near future. Business is already sitting on a mountain of cash, and even Goldman Sachs wonders if the expensing provision will do much in this environment:

The proposal includes expensing of business investment in 2011, similar to the policy that the president proposed in September. This should reduce corporate taxes by about $100 billion next year if enacted, but would increase corporate tax liabilities in future years. Given low interest rates and significant spare capacity, this proposal is likely to have a limited effect on corporate behavior.

4. The 13-month renewal of emergency unemployment benefits will almost certainly keep the unemployment rate higher than it would otherwise be. Research from the San Francisco and Chicago Federal Reserve banks suggests the unemployment rate would be 0.4 percent to 1.7 percentage points lower if not for the extended unemployment benefits.

Republicans didn’t own the Mega-Stimulus. They will own Mega-Stimulus 2.0 in the eyes of the public. Before they sign off, they may want to seek a second opinion Dr. DeMint.