FURTHER THOUGHTS ON THE TAX CUTS

The Obama tax cut plan appears less meaty than the $900B in deficit addition that is advertised.  It essentially keeps plans in place rather than adding substantively to the recovery.  All in all, the plan seems to rhyme with the Obama presidency – providing big hopes and coming up well short.  Talk about speaking loudly and carrying a small stick…..The plan breaks down approximately as follows:

  • The payroll tax cut is the only part of the plan that the President appears to have negotiated ardently for.  This portion of the cut is a reduction in social security taxes to 4.2% from 6.2% in 2011.  This would generate an additional 2% for employed workers.  Total deficit addition: $120B.
  • The Making Work Pay tax, part of the original stimulus plan, will not be extended.  This will reduce the deficit by $60B a year.
  • Unemployment benefits will be extended for 13 months maintaining $56B in the deficit.
  • The Bush tax cuts will be extended for two years with a provision protecting estates under $5MM from the estate tax.  The tax rate on qualifying estates will be 35%.  This is projected to add less than $10B to the deficit.
  • The Earned Income Tax Credit, the Child Tax Credit and the American Opportunity Tax Credit, all parts of the stimulus plan will be extended.   This will maintain $40B in the current deficit.
  • The President’s business expensing plan is passed.  This breaks down as follows and adds up to $200B to the deficit in the next two years:

1) Accelerate $150 billion in tax cuts to 2 million businesses: 100 percent expensing will accelerate $150 billion in tax cuts to 2 million businesses – providing $200 billion in relief over the next two years when combined with small business expensing and bonus depreciation provisions the President signed into law last month.
2) Lower the average cost of capital for business investment by more than 75 percent: Through temporary 100 percent expensing, Treasury estimates that businesses’ average cost of capital on new investments will fall from 7.18 percent to 1.68 percent – providing an incentive to pursue a broader range of investments through the end of 2011
3) Produce about $50 billion in new investment: Studies of similar tax cuts in the past have found they encouraged businesses to increase targeted investments. Based on the results of one such study, Treasury estimates 100 percent expensing could support $50 billion in new investment, while other outside estimates have projected an even larger impact.

So, in essence, what the plan amounts to is somewhere in the ballpark of $270B in NEW stimulus over two years while mostly maintaining plans that were already in place.  At 0.9% of total GDP per year it’s safe to call this plan small at best.  It’s not going to provide a huge jolt to the economy and much of it could expire after the first year.

All in all, it looks like more political negotiating and jockeying for position in 2012 rather than doing what is in the truly best interests of the American people. This plan has something to infuriate everyone.  It’s too small to satisfy the Keynesians and too big to satisfy the libertarians. It is likely to infuriate the defaultistas, inflationistas and stock market permabears. It will also cause a great deal of fear mongering over the future of social security and how the country will pay for this additional short-fall.

The primary upside here is that we’re not succumbing to the fiscal austerity drumbeat that is dragging countries like Ireland into depression and that’s a good sign.  We’re moving further away from our 1937 moment. Unfortunately, the plan still doesn’t do much for Main Street, but that’s par for the course given the government’s response of the last few years.  So, the mediocre recovery should continue with the hope that some exogenous risk doesn’t cause a hiccup.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • BK

    TPC I’d be interested to hear your thoughts about 2012…what are the opinion polls like? Have there even been any of substance? Do you think Obama will get back?

    Whilst he has been criticised, from a far it seems the Republicans are pro austerity which would be even worse.

    What are the options…

  • http://www.pragcap.com TPC

    The big hurdle here is unemployment in my opinion. There is a very high probability that UE will be higher in 2012 than when Obama came into office. If I am a Republican strategist I am licking my chops at that ad campaign showing that Obama had 4 years to reduce the UE rate and failed. That’s a killer slogan if you ask me and would resonate with people. They’ll hammer on that and the healthcare passage and could win over Main Street easily….

    It’s an uphill battle for him from here….

  • goodfriend

    Thanks, i was looking out for such a broad picture about what i view as a key issue on the path of recovery (or not).

  • MacroLux

    If Obama doesn’t grow a pair and start fighting for things that his base believes in and that which makes economic sense, he is going to lose 2012. He is too open for compromise with a party who have explicitly stated they will block everything he passes unless it attempts to cut taxes (for the wealthy) or reduce the size of government).

    There is one small hope – Palin, if she wins the republican nomination, Obama should be able to crush her.

  • But What Do I Know?

    What about the AMT fix? I haven’t read anything about it, and that makes me suspicious. . .

    Given the expiration of Making Work Pay, this plan is a wash for the first $20K of singles’ and $40 K of married couples’ income, and adds up to only $200 per $10K after that, so it is effectively no tax break for the bottom half of wage-earners.

  • B Ferro

    The plans seems perfectly constructed for what we increasingly have to deal with – a muddle through type scenario. Muddle through policies (not good, but not austerity) for a muddle through economy (not good, but no recession).

  • mlb

    Seems to me this brings us further down the path of “make the already-rich even richer in hopes that they throw a few table scraps at the poor.” How is this sort of economic policy morally justified? We are sowing the seeds of revolution and no one will see it coming – making it all the more dangerous. Crude oil will be $100 in just a few days at this rate.

  • mb

    “The primary upside here is that we’re not succumbing to the fiscal austerity drumbeat”

    Of course not, it will be forced upon us at the worst possible time.

  • Dimm

    what a waste. tax cuts do not work. it is a fact.
    Obama is a huge disappointment. I wish Clinton won. At lest she had what it takes to accomplish something.

  • Dimm

    http://www.economy.com/mark-zandi/documents/Small%20Business_7_24_08.pdf

    Mark Zandi:

    Highlight: Make Bush Income Tax Cuts Permanent 0.29 ….

    Fiscal Bang for the Buck
    One-year $ change in real GDP per $ reduction in federal tax revenue or increase in spending
    Tax Cuts
    Nonrefundable Lump-Sum Tax Rebate 1.02
    Refundable Lump-Sum Tax Rebate 1.26
    Temporary Tax Cuts
    Payroll Tax Holiday 1.29
    Across the Board Tax Cut 1.03
    Accelerated Depreciation 0.27
    Permanent Tax Cuts
    Extend Alternative Minimum Tax Patch 0.48
    Make Bush Income Tax Cuts Permanent 0.29
    Make Dividend and Capital Gains Tax Cuts Permanent 0.37
    Cut Corporate Tax Rate 0.30
    Spending Increases
    Extend Unemployment Insurance Benefits 1.64
    Temporarily Increase Food Stamps 1.73
    Issue General Aid to State Governments 1.36
    Increase Infrastructure Spending 1.59

  • Mountaineer

    Hatzius expects this will keep the deficit above $1T through 2012. That’s the main point, no 1937 moment. Plenty of fiscal support for the private sector. Nowhere near the right allocation and not as much as I would like, but still a big number.

    http://www.zerohedge.com/article/goldman-giddy-government-generosity

  • mutant_dog

    The problem for Obama is, “things that his base believes in and that make economic sense” are a null set. Correct me if I’m wrong, I may have missed something…

  • SDW

    A spokesperson for Harry Reid called the results of Obama’s negotiations with the Republicans “An interesting idea.”

    This is not a done deal. And the US government doesn’t work by presidential fiat. Stay tuned.

  • http://www.pragcap.com TPC

    Dimm,

    There was no way we were going to pass an infrastructure bill or something of that sort. This, sadly, is about as good as it gets…..

  • http://www.pragcap.com TPC

    Yes, key here being:

    4. The package obviously has implications for the deficit that we will also work out once more details are known. Our latest estimates, $1.25trn for FY 2011 and $1trn for FY 2012, were already under review for adjustments to accommodate our stronger growth forecast. On balance, we would expect the FY 2011 figure to rise, but probably not by much more than $100bn, while the net implications of these changes for the FY 2012 deficit are less clear. We would not expect significant increases in coupon issuance as a result, as the Treasury Department had stopped cutting the sizes of these auctions before it needed to. Our current thinking is that most, if not all, of any increased borrowing is apt to occur in bills.

    Not bad, not great.

  • Dimm

    TPC, I understand that, but it is still sad to see that the country is pretty much ungovernable :(

    What I do not understand is why the deficit is not a problem anymore? Adding $900 B to the deficit is not a problem, but the unemployment benefits themselves were a huge problem. Where is the screaming? I thought the deficit hawks wanted to offset all future spending. Utter hypocrisy

  • MJJP

    Palin won’t win the Republican nomination because Obama will have switched parties by then.

  • http://www.pragcap.com TPC

    Well, there’s obviously a fundamental flaw in the way that these people think of the monetary policy. It’s absurd, but if I asked 100 people if they wanted a tax cut they’d all say yes. If I asked those same 100 people if the USA can afford to spend more money I’ll bet 90 of them would say no. People just don’t get this stuff….even the most basic stuff. The country is governed by lawyers and not people who really understand how a monetary system works…..

  • AWF

    I thought the overall plan to be pretty good.

    NO Tax increase for people who are WORKING plus a little decrease in Payroll tax

    BTW–A Republican Idea–pushed many times previously

    Extend the Unemployment Benefits 13 Months–Humane and Moral

    BTW–Both a Democrat and Republican Idea

    Business Incentives–Republican Ideas

    BTW–There has been and is plenty of wastefull govrnment spending that could be attritioned to pay for these incentives.

    Some might say the 1st Obama stimulus was a complete waste–I’m not one to praise Ceasar– but the results speak for themselves.

    The Takeway:

    This version of stimulus is stockmarket positive–hopefully thru the first quarter of next year.

  • Tom Hickey

    Again, too little, too late, and misdirected to boot. Fail.

  • Adam Ruchka

    When everyone was still wearing their ‘Yes We Can’ pins, Robert Prechter made what’s proving to be a prescient comment that Obama would leave office with lower approval ratings than Bush. This may prove true.

    Assuming it does – the tax cut extension could go from 2 years to permanent very quickly with the thrust of a republican administration in 2012.

  • George H

    TPC,

    Goldman had a forecast of 1450 for 2011. Now it upgrades its GDP forecast by at least 0.5%. Does this make you a bull and start putting money in?

  • http://www.pragcap.com TPC

    My tactical approach has not changed, but it’s also relatively unique. As I said the other day I still believe we are in a secular bear as long as these global imbalances continue. So, I will continue to use the same multi-strategy approach that I’ve been using for the last 5 years. It’s treated me quite well so why fix what isn’t broken? I am leaning towards finding shorts again in the near-term….

    http://pragcap.com/questions-2011

    If I were a buy and hold investor I would be feeling better about 2011 than I did a few months ago….To me, it’s all about earnings and the earnings picture is consistent with continued rising equity prices….

    http://pragcap.com/expectation-ratio-continues-forecast-positive-earnings-trends

  • roger erickson

    thanks for that; best laugh this week; sadly true

  • roger erickson

    it’s not operationally justified; the morality will take longer to sink in

  • roger erickson

    you guys are on a roll; the laughs just keep coming;
    until you read the fine print, you’d actually believe a meaningful tax cut is appearing

  • roger erickson

    Dimm,
    it’s the ratio of currency-creation / taxes that matter; you can work on the numerator or denominator, or both; take your pick

    the point of greasing aggregate demand is to distribute enough currency so that all people with transactions to denominate can do so efficiently, instead of waiting, or resorting to barter

    with cash in hand, and transactions humming, everyone’s delinquent mortgage becomes serviceable again

    only problem is that investment bankers don’t get bonuses for moving money around

    As my local church sign says “This ain’t Rocket Surgery” (or sound currency mgt, either)

  • roger erickson

    Yes, it fails on many counts; but at least it’s not going to get dramatically worse.
    We were that close to actually freezing currency supply (balancing the budget) for a population growing in both size and rate of economic activity.

    This at least averts catastrophe – which almost feels like a full pardon.

  • roger erickson

    don’t count ANY chickens until this moronic political process plays out;

    no one’s yet said how they’re going to justify throwing the B-Punitive Commission under the bus

    (maybe have the Humane Society just quietly rescue them?)

    is there an Old Deficit Terrorist Home somewhere? Maybe Cheney’s secret location?

  • Dimm

    I thought the deficit was the only thing that mattered.
    Choosing the least effective way to stimulate the economy is not a win.
    Holding the country hostage so the multimillionaires get a tax cut, while refusing to provide support to the unemployed for a fraction of the cost of the former can only be done by sociopaths.

  • Alan

    Interesting dynamics. With a Republican House ready to vote for it, and 48? Republicans in the Senate, how much Democratic support does he need?

    I think he’s committed enough to his ideology not to want to triangulate like Clinton, but the more childish Dems in his caucus may force him into it by default.

    Crazy world.

  • roger erickson

    ?? no rational people care about fiat bookkeeping, only about the real output & capability gap

    the deficit is just on paper; fiat currency ==> fiat debt; we can make up as much as we want to scare the kids, but if it’s made up, we can always make up as much currency as we want to service the pretend debt

    currency issuers manage real goods budgets

    currency users manage currency budgets (as an accurate proxy for their local real goods budget)

    if this isn’t entirely clear, try this link: http://www.moslereconomics.com/?p=8662/

  • Dimm

    sorry I should have indicated the sarcasm about the deficit.

    I think Bill Mitchell ( http://bilbo.economicoutlook.net/blog/ ) explains it better then Mosler.

  • roger erickson

    my apologies; didn’t see you or it coming;

    agreed on Mitchell’s clarity, but Mosler’s text is far shorter for an intro

  • roger erickson

    sure Goldman would be giddy; unlike 1937 these tax distributions much keep more of the deficit as upper income private savings

    Main St. may even applaud, right up until the bus doesn’t stop at their busstop

    but no matter, there are jobs guaranteed for the poor

    “A top Pentagon chief says the DREAM Act would be a great way to expand the pool of potential recruits for the country’s armed forces.”
    http://latino.foxnews.com/latino/politics/2010/12/07/young-immigrants-dream-recruits-chief-says/

    so now we have 1938, plus 2 wars, plus draft-free recruits, AND the profits all stay in the upper class this time; it’s the New Old Deal; Hoover would be proud, & Bush too

  • George H

    Thanks.

  • G

    This is a gamble by Obama. There is a tacit admission that his economic policies have failed, but it is also a much-needed compromise to support recovery in the US. If it is doesn’t work to promote recovery, Obama will have very few cards left to play.
    http://www.mindfulmoney.co.uk/2676/economic-impact/obama-gambles-with-tax-cuts-but-what-about-the-jobs-man.html