Support the tax deal

Terms of the deal

Here’s what I understand the deal to be:

• Extended for two years, through December 31, 2012:
  • All 2010 individual income tax rates;
  • 2010 capital gains and dividend rates (15%/5%);
  • Expanded Earned Income Credit is extended for two years
  • Expanded child credit is extended for two years
  • “American Opportunity” (education) tax credit
  • Alternative Minimum Taxes as in the McConnell bill, such that no additional taxpayers face AMT
• Estate and gift taxes return, with a $5 million per person exemption and a 35% rate. After 2012 they would revert to pre-Bush levels ($1 M / 55%)
• Full expensing of business investment for all non-property investment for all businesses made between September 8, 2010 and December 31, 2011. 50% expensing for investment made in 2012.
• Extended unemployment insurance benefits are available through December 31, 2011.
• Two percent payroll tax credit for 2011 (employee side, replaces the refundable Making Work Pay credit)
• The smorgasbord of “extender” provisions will run for two years, which is retroactive for 2010 and prospectively for 2011. Details on this are still TBD and are undoubtedly occupying nearly every tax lobbyist in town. (ick)

Analysis

Given a Democratic President, this is the best possible deal that could be reasonably expected. For the next two years, through the remainder of President Obama’s first/only term, tax rates won’t go up on anyone except dead people. (OK, actually their heirs.) That is a total and complete policy win.

With almost no political effort and very little public discussion, capital tax rates aren’t going up. I had expected Congressional Republicans to get two years on all the individual rates but was nervous about the capital tax rates. That is a slightly surprising and complete policy win.

The estate & gift tax deal ends up at the Kyl/Lincoln compromise levels, as most anyone could have guessed for a while. While this isn’t a complete victory, it’s darn good.

The stupid Making Work Pay credit, which the President mislabeled as a tax cut, is now a true payroll tax cut. That’s a marginal improvement.

Unlike many Congressional Republicans, I support extending extended unemployment insurance benefits when the unemployment rate is this high. My back-of-the-envelope suggests that, at a 9.8% rate, between four and nine people who would like a job but cannot find one are getting more generous UI benefits for each person who is getting those same benefits and choosing not to take a job. I’m OK with that ratio.

If I could make two changes to the bill, I’d pay for the increased spending on unemployment insurance with spending cuts in the outyears, and I’d drop the accounting gimmick that doesn’t lower future Social Security obligations to account for the lower payroll tax revenues.

If I could make a third change, I’d drop the business expensing. This provision is a timing shift – it will cause firms to accelerate their medium-to-long-term investment spending into 2011. That’s good for 2011 growth but bad for 2013 and 2014 growth. Since I accept the consensus predictions that we’re in a multi-year slow recovery, that’s not a constructive change. There are times when this makes sense. I don’t think this is one of them, but I’m open to opposing arguments.

And while the small extenders are mostly icky special interest provisions, I’ll hold my nose on these once again, at least for now.

These are, however, relatively minor complaints. This bill is an enormous policy win because the effective changes actually go beyond 2012. Along with the actual changes to law through 2012, this bill should change your expectations of rates beyond 2012. By far the most likely legislative scenario in 2012 is that we repeat this whole scenario and go another 2-4 years without raising taxes. All the arguments that were effective in 2010 will be as effective in 2012, and Congress will already have cast this extension vote once. The tax rates, in effect, become just another “extender” vote. At the moment I’d give 4:1 odds against these rates increasing in 2013.

Compared to what?

I’ll guess that some conservatives will complain that both the rate cuts and the payroll tax cut will have only limited supply-side growth effects because they are temporary. Some may then get sloppy and say “temporary tax cuts don’t create growth.”

Yes, they do, they just don’t create as much growth as permanently lower rates. Permanently lower rates are better than lower rates for two years, but lower rates for two years are better than higher rates beginning 24 days from now.

For many higher income earners the 2% payroll tax cut reduces their average but not their marginal tax rate. I could design a package of income tax rate cuts that I’d prefer to the 2% payroll tax cut, but so what? It’s silly to compare this bill to any one person’s ideal tax policy and say it’s inadequate. This is legislating, not a theoretical tax seminar.

And isn’t letting people keep more of their wages a good idea even if for some it doesn’t have a big supply-side effect?

For those concerned with the deficit increase associated with the UI benefits, I agree that’s a problem. On the upside, the President’s Labor Day proposal to increase highway spending by $50B – $100B just became a lot less likely, as the business expensing provision with which it was packaged is being enacted here.

Recommendation

No-brainer. Support the deal.

(photo credit: FaceMePLS)