Tax Package A Plus, But Maybe Not Enough

Will the tax cut compromise proposed by President Obama be enough to bring the economy out of the doldrums? Economists have mixed opinions.

Liberal economists are concerned that the package, which would require congressional approval, will provide only a limited boost to the economy, at a substantial cost. Conservatives believe that extending current tax rates for two years offers less benefit than a permanent reduction would have done.

Tax Cut Compromise

The deal President Obama reached with congressional Republicans would:

— Extend the Bush-era tax cuts, including for the wealthiest Americans, for two years. The president had wanted to end the tax cuts on income in excess of $250,000, while the Republicans had wanted to make the cuts permanent for all income levels.

— Prevent the alternative minimum tax from hitting an additional 21 million households.

— Extend unemployment benefits through the end of next year for workers laid off for more than 26 weeks and fewer than 99 weeks. Obama pushed for this and for continuing tax breaks from the stimulus package for working families and small businesses in exchange for extending the Bush tax cuts to the wealthiest.

— Reduce Social Security taxes paid by workers for one year, from 6.2 percent of income to 4.2 percent. For example, a worker earning $40,000 a year would receive an $800 benefit.

— Temporarily reinstate the estate tax at a rate of 35 percent for estates worth more than $5 million. Democrats had favored a 45 percent rate, starting at estates worth more than $3.5 million.

— Extend a variety of tax breaks:

  • for lower- and middle-income families — such as the earned income tax credit, the child credit and the college tuition credit.
  • for businesses, including a research tax credit. In addition, they can write off 100 percent of capital investments next year.
Sources: NPR, The Associated Press, The White House

Yet most economists seem to agree that failing to extend the so-called Bush tax cuts would have harmful effects in the coming year.

"It avoids a drag on the economy," says David Wyss, chief economist for Standard & Poor's, a rating agency. "The costs of allowing the cuts to expire would have been substantial."

Although the package, which also extends unemployment benefits, should serve the short-term goal of boosting the economy, many economists are concerned about the implications of tacking on nearly another $1 trillion to the national debt.

"Extending the tax cuts is better in the short term than not doing it," says Leonard Burman, an economist at Syracuse University. "But the long-term effects are really frightening."

More Stimulus Than Expected

The package, agreed to between Obama and Republican congressional leaders, includes more than an extension of the Bush-era cuts to income and capital-gains rates, which are otherwise set to expire Dec. 31.

In addition to an extension of unemployment benefits, the package would cut payroll taxes for employees, which fund Social Security, and offer breaks for businesses, such as write-offs on equipment purchases.

The payroll tax deduction could provide upwards of $2,000 to some households next year, while the unemployment extension would put $60 billion or more into the economy.

"It's a lot of stimulus being added, more than we expected," Wyss says.

But Was It Enough?

The size of the package is enough to ensure a stimulative shot in the arm for the economy, says Alan Viard, a former senior economist at the Federal Reserve Bank of Dallas who is now at the conservative American Enterprise Institute.

But he cautions that the Bush tax cuts are not ideally suited to increasing demand. Despite Obama's stated desire to limit the tax breaks to income under $250,000, the income tax cuts would be preserved for all levels of income under this deal. And high-income individuals will pocket some of the savings, he says, spending a smaller share than low- and middle-income workers.

The real issue, Viard suggests, is that because the tax rates would only be extended for two years, people will make limited changes to their spending and investment habits. Businesses are also less likely to alter their capital investment plans if they don't know whether tax rates will revert to Clinton-era levels in 2013.

"There will be some modest, short-run stimulus to consumption spending, but I don't expect it to have a really great impact," says Barry Poulson, a retired University of Colorado economist and adjunct scholar at the Heritage Foundation, another conservative think tank.

"The alternative would have been a permanent reduction in tax rates, like Reagan did in the 1980s," Poulson says. "When you get a permanent reduction, then you really see a stimulative impact on consumption, investment, spending and so forth."

Long-Term Dangers

Outlining the package Monday, Obama stressed the importance of reaching a deal to avoid sudden tax increases in 2011 that could further dampen the economy. "Allowing taxes to go up on all Americans would have raised taxes by $3,000 for the typical American family," he said. "And that could cost our economy well over a million jobs."

While economists share the president's concern that increasing tax rates would have hurt the economy, they are also concerned about the package's long-term costs.

Viard worries that, following the flurry of debt-reduction-commission reports that seemed at the top of Washington's agenda recently, the tax package "kicks the key decisions two years down the road." But he suggests that taking on more debt was unavoidable, under the circumstances.

"We're adding a substantial amount to the national debt," Viard says. "On the other hand, everyone always understood that we can't really get serious about reducing the national debt until we're on a stronger economic footing."

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