Comments on the Tax Deal

[dan_s]

Daniel Gross, On Tuesday December 7, 2010, 9:48 am EST

It's taken two years, but President Obama and Congressional Republicans may finally have found something they can agree on. Over the weekend, the contours of a deal on taxes emerged, and Obama announced details of the compromise Monday evening. The existing tax rates on income and investments will stay where they are for the next two years, rather than rise on January 1. In return, President Obama won a bunch of concessions on short-term fiscal stimulus.

To a large degree, the deal represents a shift in strategy and tactics by the White House. But this isn't a sign of Obama tacking to the center, or even triangulating between Democrats and Republicans. It's a sign of Obama tacking toward reality. For the past two years, Obama & Co. had wagered that simply governing, proposing, and enacting solutions to long-term problems (health care, the bankruptcy of most of the domestic auto industry and financial sector) and presiding over incremental improvements from the horrible situation they inherited would be sufficient to maintain popularity and prospects for re-election. That theory came apart with the big losses in November.

Once the shock of the November election wore off, Obama recognized that the slow pace of recovery and jobs growth are the greatest threats to a second presidential term. And so he was eager to cut a deal on taxes. Never mind that the tax cuts were designed to expire at the end of this year. And never mind that keeping them intact on the highest earners would have little impact on overall economic growth. His problem is that he believes — and virtually every economist agrees — that the economy needs more stimulus. But throughout 2010, even with Democratic control of both Houses of Congress, the administration found that further fiscal stimulus was foreclosed. Tax credits for new jobs and extended unemployment benefits were stymied by the willingness of the Republican Senate caucus to hold once-routine measures hostage. That left the Federal Reserve, with its dwindling ammunition and credibility, as the sole stimulative force. And as recent experience has shown, allowing banks to borrow money more cheaply doesn't quickly filter into more hiring and more consumer spending.

Since January 2009, Republicans, time and again, have proven willing to vote against legislative items they once supported — on health care, on the environment, on weapons control — simply because they thought their passage would benefit Democrats politically. But there's one thing Republicans care about more than anything: lower taxes, especially for the wealthy. By caving to the Republicans on marginal income tax rates, Obama was able to extract the short-term, largely progressive stimulus he badly needs.

Republicans signed off on a payroll tax holiday, reducing the Social Security tax from 6.2 percent to 4.2 percent for 2011. Because the tax is regressive — it falls on the first $100,000 or so of all payroll income — this is a progressive tax cut. It puts money into the hands of all workers instantly, and could provide $120 billion in stimulus in 2011. As Charles Babington of the Associated Press noted: "More than three-fourths of all Americans pay more in these so-called payroll taxes than in federal income taxes."

Republicans also agreed to the payment of extended unemployment benefits through the end of 2011. This represents an important source of cash for people at lower income levels. More important, it takes an item of perpetual disagreement off the table for 12 months. Every time Republicans stonewalled extension, it made the White House look impotent.

Businesses were also given a sweetener — next year they can write off 100 percent of new investments in capital goods, up from 50 percent this year. Taken together, these three items should spur additional spending, investment, and — it's hoped — jobs in 2011.

(Aside from corporations, the only people who will have to make substantial changes in tax preparation in 2011 are the handful of folks who expect to leave estates valued at more than $5 million. The proposed deal would ward off a sharp increase in the estate tax, and have only the portion of estates worth more than $5 million be taxed at a 35 percent rate.)

At root, the willingness to deal illustrates a point the punditocracy largely misses. To a large degree, electoral success is a function of macroeconomic success. The work of political scientists like John Sides and Seth Masket convincingly shows a marked connection between economic performance and the degree to which voters are willing to reward incumbents. Economist Ray Fair of Yale University has models that predict, with a good deal of accuracy, the outcomes of presidential and Congressional elections based on a model that includes data on GDP growth, inflation, and unemployment. Simply put, when economic growth has been above trend in the quarters leading up to an election, and inflation is low, the incumbent usually wins.

So what would seem to be a new step toward bipartisanship is in fact partisanship by other means. Obama is gambling that the risk he takes by angering his own base is worth the reward of potentially higher growth in 2011 and 2012. Macroeconomic Advisers, one of the forecasters I trust the most, now projects growth of 3.7 percent for 2011 and 4.0 percent for 2012. Should that come good, it would boost President Obama's re-election prospects much more than if he were to go on an Outward Bound expedition with Mitch McConnell and John Boehner.

The deal will present a new set of problems. Republicans will take credit for stopping tax hikes, but pin responsibility for the much larger deficits on Obama. They'll continue to filibuster everything in Washington, including the buffet in the Senate dining room. That's just how they roll.

What's more, the extensions are for two years, meaning they will come up again in the fall of 2012 and early 2013. Obama's making a wager that this deal makes it more likely he'll be president when the time comes to cut the next deal on tax rates.

[mdwitte]

SHEESH! I had to wait all the way to the 2nd paragraph for this guy to show his political position!