Tax Deal: Good or Bad Stimulus?

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The second round of stimulus is not focused on roads (Photo: Rick Wilking/REUTERS)

Much of the analysis of the tax deal on the day after it was struck had to do whether it was good or bad politics. The conventional wisdom is that Obama traded the extension of lower tax rates for the rich for a second round of stimulus. If the stimulus boost the economy, it probably was a good political move. So the next question should be will this stimulus be any good, and could it have been better?

The most comprehensive analysis to come out on how much the tax deal will help the economy is from the Center for American Progress. Their estimate is that the combination of tax cuts will give a 2.2 million job boost to the economy. Not bad. Some, though, have come to the conclusion that for the same amount of money you could probably produce a tax deal that would have created many more jobs. Perhaps. Here’s why:

Most everyone agrees that tax cuts will boost the economy. The question is how much. Check out the chart that shows how the Center for American Progress’ came to its conclusion that the tax deal boost employment by 2.2 million jobs.

As you see, there are actually two boxes in the chart. The one on the left is the analysis of the current tax deal. The one on the right is what the researchers Michael Linden and Michael Ettlinger think for the same cost might have produced another 500,000 jobs. Basically the issue that the Center for American Progress and others have with the tax deal has to do with the payroll tax.

Linden and Ettlinger like the payroll tax so much they think it should have been doubled. But a number of bloggers have been smart to point out there are problems will the idea that the payroll tax will significantly boost the economy. In the deal, social security payroll taxes will drop by 2% for employees. Employers, though, will pay the same thing. And that makes Megan McArdle, at Atlantic.com, unhappy.

But I see the payroll tax as a fundamentally political move, not a serious attempt to fix the economy.  Cutting payroll taxes on workers means they will notice a little more money in their paycheck, and be happy with Obama.  The unemployed won’t be any happier, of course, but they have extended benefits, and few of them will realize that a differently structured tax cut might have given them a slightly better shot at finding a job.

The point here is that if you gave the tax break to employers that would lower the cost of labor and maybe they would hire more people. Felix Salmon is not so sure.

I still think that for three main reasons, employee-side cuts make sense right now. The experience of the last cuts shows how invisible they are and therefore how likely they are to be spent; the size of corporate cash piles shows how unwilling companies are to reinvest extra temporary cashflow; and in general employers are richer than employees, so giving the tax cut to them seems regressive.

I think Salmon’s point is the strongest. The cost of labor has very little to do with why companies are not hiring. They are not hiring because people are not spending, and therefore they don’t need to produce anymore goods or services.

My problem with the payroll tax is that as with any tax stimulus you get more bang for your buck if you put as much as possible in the hands of people who need the money. The middle class tends to use money they get these days to pay down debt. The upper-upper class saves it. But give money to families making $40,000 or less and there is a very good chance they will immediately spend it. The problem is the payroll tax is not nearly as progressive as it appears. My analysis yesterday estimated that 22% of the payroll tax benefit will end up in wallets of families who make $166,000 or more a year. But that may have been low. According to a report from the Center on Budget and Policy Priorities from early 2009, the highest income fifth of all US households will receive half of the benefit of the payroll tax cut. Indeed, under the current plan, households making less than $20,000 a year, will actually have to pay more in taxes in 2011 than they did in 2010, due to the expiration of a payroll tax boost from the first stimulus bill.

So how could the deal have done better? The low-income tax credits amount to a meager $38 billion. The retired are getting to keep the 15% rate on investment income. In two years that could produce savings of $25 billion. The result: just $63 billion of the $900 billion dollar deal is focused directly on segments of the population that if they had more cash, they probably would spend it. And that’s not just a missed opportunity for the poor and elderly. It’s a missed opportunity for all of us. So will the tax deal create jobs? Certainly. Could it have created more? Probably.

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