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Is the Tax Cut Deal a Second Stimulus?

The White House sent around a fact sheet on the framework agreement on the tax cuts, and they stressed that it would “create jobs and accelerate economic growth” without adding to medium- and long-term deficits. This has been best expressed by David Leonhardt in his story musing about the framework representing a second stimulus:

What actually seems to be happening: Democrats and Republicans agree to extend all the tax cuts and also agree to an extension of unemployment benefits, a cut in the payroll tax and, according to my colleagues, “continuation of a college-tuition tax credit for some families, an expansion of the earned income tax credit and a provision to allow businesses to write off the cost of certain equipment purchases.” The amount of money pumped into the ailing economy: about $900 billion over years.

Subtract the $400 billion cost of the Bush tax cuts. Subtract another $140 billion or so, which is the cost of extending the Alternative Minimum Tax patch (and almost certainly would have happened regardless). You’re then left with more than $300 billion in net stimulus over two years. And while that sum will not be enough to fix the economy all by itself, it is serious money. The original stimulus bill cost about $800 billion, and most of the money will have been spent in the first two years after its passage.

This deal looks an awful lot like a second stimulus.

Is this true? Most of the measures in here just carry current law into 2011 and 2012. They are anti-contractionary, and I think we need to deficit-spend at this point, so I’m happy to not contract – but I don’t think you can judge them as stimulative. The additional items include a doubling of the Making Work Pay tax cut impact with the $120 billion payroll tax cut in 2011 (Making Work Pay would have cost $60 billion), and the $56 billion or so in unemployment insurance extensions (which is also current law, sort of, but we’ll call it new money). That’s more like $116 billion in stimulus that is new. In a $13 trillion dollar economy, it’s not much.

In fact, if you run the numbers I don’t think you can say that this will stimulate the economy in a meaningful way.

Based on his back-of-the-envelope math, Dean Baker of the Center for Economic Policy Research told TPM that a year-long extension of the stimulus tax cuts “should lower the unemployment rate three to four tenths of a percentage point.”

In November, the Economic Policy Institute calculated that the a year-long extension of unemployment benefits would generate 700,000 jobs.

“We find, using the CBO’s methodology, that the $65 billion spent on unemployment insurance extensions through 2011 would support 723,000 full-time equivalent jobs,” wrote Heidi Shierholz and Larry Mishel. “If this program is discontinued, then the economy will lose these jobs.”

With unemployment near 10 percent, “It’s not trivial, but it’s an order of magnitude less than what we should be looking for,” Baker said.

Krugman’s back-of-the-envelope calculations are relatively minor as well; basically a reduction of 0.3-0.4% of the unemployment rate over two years, with the impact fading out in 2012, right during the election. This is the heart of Nancy Altman’s concern, that there will be a lot of impetus not to end the payroll tax cut, threatening the finances of Social Security, at first rhetorically and before long for real.

OK, but that’s not Leonhardt’s real point, is it? He’s comparing what would happen under this deal and what would happen in a world with no stimulus, and finding this to be the better option. Does that make sense?

Yes, to a point. It’s an indication that we need more demand generated by government, even if the stimulus itself is almost entirely tax cut-based, which is weak.

But this only holds if you believe that the Congress and the President will undergo no contractionary fiscal policies in 2011 and 2012. The President broke from that last week with his announcement of a federal worker pay freeze. And there’s good indication that we’re only at the beginning of the deficit reduction. I simply don’t think that, after dozens of deficit plans and a new Tea Party-infused House which rode in decrying government spending, that the baseline of spending will remain intact, and that these deficit-obsessed politicians will live with a $900 billion dollar, two-year increase over the baseline. The Chair of the Senate and House Budget Committees are united in thinking that the Catfood Commission plans didn’t cut deep enough. They’ll be writing the budgets for the next two years. Over a dozen Senate Democrats urged the President to address the deficit. The President has been incredibly amenable to this plea over the past couple years, albeit with more symbolic actions like a discretionary spending freeze and the pay freeze for public workers.

So does anyone actually believe that this “stimulus” will hold? You have to look at fiscal policy in the whole. If this plan increases demand, a slash to other government programs would cut it. And this plan practically ensures those slashes will occur. Sure, the President has a veto pen; but the Republicans have leverage with both the funding of the government, and more crucially, the raising of the debt limit, which is inexplicably not in this deal.

No Democrat should support this compromise without this issue being addressed. The debt ceiling is going to be hit sometime early next year, between February and April. Alan Simpson is already bragging about how this vote will be a “bloodbath”, forcing the austerity agenda into action. It would not surprise me if the new Congress moved to cut back on the stimulus program and force deep cuts at that moment when this new stimulus is getting going, and the idea that Obama will show leadership in averting this crisis can no longer be assumed.

Since this is a compromise, there should be no room for the GOP to turn around and slash aggregate demand a third of the way into 2010. This compromise gives cover for each side to extend deficits to benefit core constituencies. If the GOP come back for those struggling to get back into productive work in this weak recovery with slashing the budget (and of course leaving the high-end tax cuts in place), liberals will have been rolled.

The Catfood Commission included a payroll tax cut in their plan as a consideration. They banked on the fact that hitting the debt ceiling could cause a shock, and that their plan would be the one taken off the shelf to put into action. You cannot look at this deal without accounting for that.

I think getting unemployment insurance extended is smart and important, and an employee-side payroll tax cut theoretically should increase demand. The price was high, however, and the stimulative effects can easily be offset in the new Congress if the President buckles to the forces of austerity.

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David Dayen

David Dayen