Had the White House not reached this deal with the Republicans, about $700 billion in tax cuts and unemployment insurance benefits would have expired over the next two years, a cut in business and household after-tax incomes equal to about 2.5 percent of GDP each year. This is a hit the economy could ill afford.
As a result of the tax compromise, workers unemployed for more than 26 weeks will be able to continue collecting federal unemployment benefits for the next 13 months. With unemployment hovering just under 10 percent, and 40 percent of the unemployed jobless for more than 26 weeks, cutting these benefits could have meant destitution and despair for millions of workers. Unfortunately, many of the benefits of the tax cuts go to high earners, who did especially well in the compromise deal. For upper income households, the deal provides a 2-year extension of the Bush tax cuts, keeps the maximum tax rate on stock dividends at 15 percent, keeps the maximum tax rate on capital gains at 15 percent, retains the tax loophole that taxes the millions earned by private equity managers at 15 percent, and exempts estates up to $5,000,000 from inheritance taxes and sets the tax rate on inheritances in excess of $5 million at 35 percent, the lowest since 1931 (not counting this year when it was allowed to lapse entirely). Middle class and working families will continue to receive the Bush tax cuts and marriage penalty tax relief, will have access to the $1,000 refundable child tax credit and to a tax credit for higher education tuition expenses and, for low-income working families, the earned income tax credit expansion. The tax cut deal also extends the R&D tax credit and other business tax breaks for two years. Thus, the bulk of the tax relief in the compromise deal goes to keep programs that were in effect in 2010 from expiring in 2011.
The tax cut deal does include some modest new help for the economy. A one-year 2 percent reduction in employee payroll taxes, worth about $120 billion to working families, replaces the Making Work Pay tax credit, worth about $60 billion, that will now be allowed to expire. Businesses will get to expense 100 percent of business investment in 2011 and 50 percent in 2012 – a potentially large tax cut for new investment in the next 2 years that is partly repaid in subsequent years. Together, this amounts to about $100 billion in new tax cuts in 2011 compared to 2010 with a further boost for business investment in 2012.
While the tax compromise means policy makers in Washington have not made things worse, little in this deal promotes economic expansion and job growth. Tax cuts are the least effective means of spurring growth. The $60 billion in additional tax relief from the payroll tax cut will likely translate into $30 to 40 billion of spending, a very small stimulus to economic growth of less than 0.3 percent of GDP. This is a very modest boost to a still-fragile recovery and weak economy that is far below its potential to produce goods and services.
Likewise, the $75 billion going to upper income households as a result of their inclusion in the extension of the Bush tax cuts will likely translate into just $25 billion of extra spending. There are much better things to do with this money. Using the $75 billion to expand the food stamps program would translate into $129 billion in spending; using it for infrastructure spending would translate into $118 billion; and using it for general aid to state governments facing large deficits and layoffs would translate into $106 billion.
The deal the President cut with his Republican adversaries is far from the best use of these funds and far too small to get job growth back on track. But the White House, which remains concerned about the health of the economy, has managed to get a deal that at least respects the basic tenet of the Hippocratic oath: First, do no harm.
This article original appeared on The Hill's Congress Blog.