Friday, April 01, 2011

2010 tax cuts vs. 2011 budget cuts

As it looks all but certain that Republicans will extract at least a $30 billion pound of flesh from the 2011 budget, endangering the recovery and thus likely boosting their own political fortunes, I thought I would re-pose a question I asked earlier this month: Which is likely to be stronger, the stimulative effect of the tax cut deal Obama cut with the GOP at the end of last year, or the destimulative drag of reduced short-term government spending?

Who won the lame duck?

The late great lame duck session of Congress in Nov-Dec 2011 was widely perceived to have been a season of accomplishment for the Democrats and President Obama. The rush of activity included repeat of Don't Ask Don't Tell, ratification of the New Start treaty -- and, on the economic front, a tax deal that, for the blood price of extending the Bush tax cuts for the wealthiest, bought Obama hundreds of billions in more efficiently stimulative tax cuts.

It was a busy time, and one thing the Democrats failed to do was pass a budget for FY 2011. That gave the incoming GOP House the opportunity to commence its budget-cutting orgy for discretionary domestic spending a year early.  That includes a head start on the drive to defund implementation and enforcement of the health care and financial reform laws.  And in its opening gambit, the Tea Party delivered.  Its proposed $61 billion in cuts would kill 700,000 jobs by the end of 2012 according to Moody's economist  Mark Zandi,, and shave 1.5-2% off GDP growth in the 2nd and 3rd quarters of this year by Goldman Sachs' estimates.  The Goldman analyst, Alec Phillips, also forecasts that actual cuts in FY 2011 will come in at about $25 billion and, once enacted, will slow growth by 1% of GDP, but that the effect of that sudden hit will fade quickly later in the year.

Question: would the U.S. economy -- and Democrats -- have been better off without the global tax deal but with a Democratic FY 2011 budget passed during the lame duck session?  Does the short-term destimulative effect of the 2011 budget we're likely to get (leaving aside any long-term damage to economic viability) fully offset, or more than offset, the stimulative effect of the tax cut package?
In terms of sheer dollar value, the tax cut package dwarfs the likely spending cuts. To extrapolate from Phillips' estimate, some $70 billion might be cut from domestic spending over the next two years. Compare that to $858 billion in tax cuts over the same period -- though half of that total is to maintain status quo ante on the Bush tax cuts and to extend an alternative minimum tax fix (which also effectively maintains the status quo for taxpayers). Democratic proposals that became part of the tax deal were worth $336 billion, according to Zandi's pre-passage estimate. Perhaps, however, the spending cuts will have a more direct effect on the economy than the tax cuts (not to say on the ultimate effectiveness of the ACA and Dodd-Frank)? 

Zandi's calculations suggest that the stimulus provided by the tax cut deal more than outstrips at least the short-term drag that even full implementation of the House spending cuts would impose. Zandi estimated that the tax cut deal would add 1.2 percentage points to GDP in 2011 and reduce the unemployment rate by the same amount. The vast bulk of that stimulus would come from Democratic proposals that became part of the package: "the 13-month extension of UI benefits...the extension of various refundable tax credit improvements enacted in the 2009 Recovery Act, the reduction in the payroll tax, and the “expensing” provision for businesses."

I have no idea what the Democrats would have had to give up during the lame duck session to get their 2011 budget passed, or whether the question is answerable.  With regard to short-term economic effects and therefore electoral effects, however, if they had been forced to choose between getting Obama's tax deal done and passing their budget, it seems that taking the deal would have been the right choice.

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