Is the Tax Deal Good For the Economy?

The deal cut by President Obama and Republicans is being hailed by the talking heads on CNBC this morning as a stimulus for the economy. Really? I suppose it is stimulus in the sense that it is better than raising taxes, but this package should not be mistaken for good economic policy. Here’s the main points:

  • Extends the current Bush tax rates for another two years: All this does is maintain the current rates. It is not a tax cut. There is no reduction in marginal rates and therefore no change to incentives. If there had been an expectation that the rates would not be extended then maybe – very weak maybe – there would be some stimulus as expectations change. But did anyone really think these rates would not be extended?
  • Sets the estate tax rate at 35% with a $5 million exemption for two years: This is actually a tax hike from 2009 rates. Whatever you think about estate taxes, this isn’t stimulus. It is a change from what was scheduled so, again, there might be some very, very, very minor change in expectations but stimulus? If it is, it is minor.
  • Extends unemployment benefits for 13 months: The idea that unemployment benefits act as stimulus has lately become popular but it seems a stretch to me. There is a much larger body of research that shows that extended benefits merely extends the length of the unemployment period. Even if you credit the extension with some minor stimulative effect, there is the offset that this is funded through more borrowing. The money has to be borrowed from someone and they would have done something with it so my guess is that this is neutral at best and probably a negative since it adds to the deficit and debt.
  • Cuts the worker portion of payroll taxes by 2%: This replaces the making work pay tax credit from the stimulus bill. For the average worker it is probably about double the credit it is replacing so there will be some increase in disposable income. Unfortunately, the cut is temporary and past cuts of a temporary nature have had little stimulative effect due to what Friedman called the permanent income hypothesis. Put simply, individuals will not change their spending habits based on a temporary change in income. Of course, contrary to what the Keynesians believe, even if it is saved there is some positive effect. Verdict? This is probably the most stimulative piece of the proposal and it is fairly weak.
  • Extends a bunch of business tax breaks: Allowing continued expensing of some capital expenditures and R&D probably does little to change companies spending plans. More likely it just provides a break for previously scheduled spending. Again, temporary doesn’t feed the bulldog.

The stock market is up today and many are crediting this compromise but I find that hard to swallow. There is nothing here that was not expected except for maybe the estate tax bit and that has little or no stimulative effect. And if the market is up because of these tax changes, why is gold up?

If this were a major positive change in economic policy we would see the flow of capital into gold start to reverse. So far that hasn’t happened, although to be fair, it is early. This deal is a minor positive for the economy – if you ignore the fact that it gets us even deeper in debt – but I don’t think this is the change we’ve been waiting for.

4 Responses to Is the Tax Deal Good For the Economy?
  1. “If this were a major positive change in economic policy we would see the flow of capital into gold start to reverse.”

    First off, you’re assuming the market for gold is rational. Gold is CLEARLY in a bubble, and will “reverse” itself in one swift downward gyration. That type of reaction is far from rational, and history is full of those market reactions.

    The deal isn’t done yet. “Now, this is far from a done deal. This package is designed to get 60 votes in the Senate, but it may not pass muster in the House. The House Democratic caucus, which is generally more progressive than their Senate counterpart, is reserving the option to revolt. And Tea Party Republicans are threatening to vote “no” because of the unemployment insurance extension that is attached.”


  2. Clearly in a bubble? Not rational? Well, that’s your opinion. I don’t happen to agree. Will gold fall rapidly when it starts to fall? Well it certainly can if policy changes. Back in 1979-80 when gold hit $850 during Volcker’s monetarism experiment, it fell rapidly as Reagan went ahead in the polls. But that was because the market was anticipating a change in policy, specifically the Reagan tax cuts. The change in policy affected the demand for dollars relative to gold. If we get a clear change in policy now that encourages productive investment then gold can certainly fall rapidly again. But that won’t be because the market is currently irrational and it suddenly decides to become rational again. It will be because policy affects the demand for dollars.

    As for whether the deal is done, I agree that it certainly isn’t yet. Obama’s left flank is not happy with this deal and may very well vote it down. If they do though, I would expect it to pass as soon as the new Congress convenes.

  3. Oh and tea party Republicans will change their tune after they are sworn in. Even tea party members have relatives on unemployment and they might be against extending benefits in theory but when their brother in law ends up on their couch, I suspect they’ll change their mind.

  4. At last our so called representatives in Congress have decided to leave our tax rates as is. Only an idiot could think it’s a good thing to raise taxes, especially in these economic times.

    But then there is no shortage of idiots in Congress today.


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