Why the president agreed to Republican demands on the Bush tax cuts.

Commentary about business and finance.
Dec. 7 2010 12:06 PM

The Stealth Stimulus

Why the president agreed to Republican demands on the Bush tax cuts.

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Because as it turns out, everybody wants to reduce the deficit, but nobody wants to actually go about doing it. Republicans got their tax cuts. Democrats got their tax cuts, plus their spending boosts. The trade was, "You can have your deficit spending if I can have mine." That adds up to a lot of deficit spending.

But that doesn't mean it will be effective. Indeed, the package, as a whole, is not nearly as stimulative per dollar as the original Recovery Act. If you give a low-income family $1 for food via food stamps, it spends it. If you give a high-asset family $1 via a tax cut, it tends to save or invest it. Either way, the transfer costs the government $1—nothing comes free here, or pays for itself, despite some wonky mathematicians' protestations. But $1 worth of food stamps adds more to the GDP than the tax dollar because it actually gets spent.

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The most stimulative spending program in the current bill is unemployment insurance, which will put $56 billion into workers' pockets over the next 13 months, a much-needed boon for those families and a quick infusion into a demand-starved economy. The payroll tax cut is among the most-stimulative tax options, leaving a bit more cash in 155 million workers' pockets.

But a whole lot of the tax changes give cash to the very wealthiest Americans and will not do much for economic growth. For instance, the estate tax will grant about $7 billion in tax cuts to the 0.14 percent of estates worth more than $5 million—money that will go to the pockets of wealthy inheritors, and will be added to the deficit, but to little to no broader economic benefit. The high-earner tax cuts will also add tens of billions to the deficit, in exchange for perhaps a 0.1 percent drop in the unemployment rate. (The middle-class tax cuts should bring the rate down two to five times more.)

A lot of this money, then, will do nothing except put the country deeper into the red. That said, if the deal goes through—and the president may have trouble selling it to his own party—it will do something to aid American families, help American businesses, and soothe markets concerned about congressional intransigence and confusion over the looming tax changes.

But stimulus is not a popular word, even within the administration, and no one likes to talk about the deficit. Tax cuts, on the other hand, are almost by definition irresistible to politicians of all stripes. That is what the president is counting on as he tries to sell this don't-call-it-stimulus plan to his fellow Democrats.

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