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.

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Cullen Roche

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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