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.

U.S. President Barack Obama. Click image to expand.
President Barack Obama

"Americans are asking just one question,"President Obama said last night. "Are we going to allow their taxes to go up on January 1st, or will we meet our responsibilities to resolve our differences and do what's necessary to speed up the recovery and get people back to work?" The answer was not, "We will allow their taxes to go up and shirk our responsibilities."

In his remarks, Obama used the word tax or taxes 33 times, whereas deficit, unemployment, and recession came in a measly four times each. One word that never appeared: stimulus. But don't let that fool you. In passing the tax compromise, Obama and his negotiators—White House budget chief Jack Lew and Treasury Secretary Tim Geithner—sneakily constructed a tax-side stimulus plan. It is big: nine digits big, as big, possibly, as the original stimulus bill. But as stimulus, it is comparatively weak.

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The compromise itself can best be described as tax cuts for tax cuts (plus extended unemployment insurance benefits). Democrats would agree to a two-year extension of all the Bush tax cuts, including those on the richest Americans and on capital-gains and dividend earnings. Democrats would also agree to reinstate the estate tax—though at rates that are really making them hold their noses: a $5 million exemption ($10 million for couples) and a 35 percent rate. (Liberals were hoping for something more like a $1 million exemption and a rate of 45 percent or 50 percent.)

In return, Republicans would agree to authorize extended unemployment benefits for 13 months, reduce the employee side of the payroll tax by two percentage points for a year, and re-up the Earned Income Tax Credit and Child Tax Credit expansions created in the 2009 stimulus package. They also continue an education tax credit and let companies fully expense business investment. Something neither party really needed to negotiate: fixing the alternative minimum tax, to avoid 21 million families getting hit by it.

On both sides of the ledger—taxing and spending—that amounts to a whole lot of cash. Of the proposal's estimated $700 billion to $900 billion cost, about $380 billion goes to provisions for the middle-class, including tax cuts, and about $80 billion to the high-end earners. The one-year payroll tax cut costs the government approximately $120 billion. The EITC, the Child Tax Credit, and American Opportunity Tax Credit (for education) take an additional $40 billion from the federal ledger. On the spending side, the big boon is for unemployment benefits, providing safety-net-level security to millions of households, most with children. The 13-month extension costs $56 billion.

All of those dollars—the tax-break dollars and the spending dollars—add to the deficit, which is another way of saying that they qualify as stimulus. Congress is using its credit card—aka the world debt market—to finance spending Americans cannot afford at the moment. This might come as a surprise to anyone paying attention to the half dozen or so (it's hard to keep track) deficit-reduction plans currently in vogue in Washington. Indeed, the announcement of the tax plan comes days after the report by the president's blue-ribbon fiscal commission on how to get the nation's spending under control, and a week after Obama proposed a two-year federal-government pay freeze.

That was last week. What changed? For one, the unemployment rate climbed to 9.8 percent, with 15 million unemployed, in November. That indicates the private-sector recovery has not really taken over since the loss of the public-sector stimulus. In addition, Federal Reserve Chairman Ben Bernanke has started agitating for more short-term fiscal stimulus in exchange for long-term deficit reduction.

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