Obama’s tax deal is stimulus 2.0 in the new era of divided government

by Russell's Rants

Originally published December 8, 2010


I am shocked, shocked that some liberal commentators would rather debate the politics of President Obama’s tax deal with Republicans this week than the economics of it. Yes, Obama campaigned on ending the Bush tax cuts on those earning greater than $250,000. Yes, he has argued that the upper 2% didn’t ask for and don’t need a continued cut. And yes, there are far better uses for the money being allocated to tax cuts for the rich.

But Obama needed a fiscal deal with the Republicans that injected more money into the economy and started producing jobs. And the $900 billion tax deal that he reached with Republicans this week is one way, probably the most politically feasible way, to do so. Look at it as a jobs bill. It’s Stimulus 2.0 for the new reality of divided government.

For every dollar spent (yes, needlessly) on the rich ($133 billion for extending the Bush tax cuts and the estate tax reduction for the top earners), it has 3.6 dollars for the poor and middle class. These come in the form of a 13-month extension of unemployment insurance ($56 billion), a 2% cut of the payroll tax ($120 billion), earned income tax credit ($40 billion) and extension of the Bush tax rates for those making under $250,000 ($300 billion). And much of the new bargaining points put on the table by Obama are, in fact, stimulative, including advanced-depreciation for businesses ($30 billion to $180 billion).

The first stimulus bill passed in early 2009 is now running out of steam. It, along with TARP and the Fed, saved the economy from dropping off a cliff after the collapse of the financial sector. Absent the first stimulus and related programs, unemployment would be probably in the range of 13 to 15% — and getting worse. Now, growth has returned. But not at a high enough rate to bring down the unemployment rate.

Obama will only be reelected if the unemployment rate is around 7% and going down by Fall of 2012. Recall, Reagan had an over 10% unemployment rate in 1982 when he suffered significant setbacks during his first mid-term election. But by 1984, with the unemployment rate at 7.2%, it was “Morning in America,” and Reagan was off to a second term.

If Obama had allowed the Bush tax rates to expire in their entirety on New Year’s Eve, the economy would not continue recovering in 2011. The bottom marginal tax rate would have increased 50% (from 10% to 15%) on New Year’s Day. Even if Obama had somehow held out and gotten the lower rate only for the middle class, that would not have been stimulus enough to prime the pump. Recall that the first stimulus package was 50% too small ($800 billion when Christina Romer calculated that it should have been $1.2 trillion). And also recall that even in the first stimulus, in order to get just a few moderate Republican votes, about a quarter went to tax cuts that did not have the same multiplier effect in the economy as spending programs. The fact is that the only mechanism at the disposal of elected government officials to spur growth in a recession is deficit spending (either in the form of spending or tax cuts). The first stimulus was mostly the former, the second is almost all the latter.

Obama looks bipartisan and presidential in striking a deal to move the country forward, and he has preserved the issue of tax fairness as a campaign issue for 2012. Indeed, once he deals with short-term stimulus (which requires, in fact demands, short-term debt), he can pivot to long-term deficit reduction and income inequality, for which his presidential commission just fired the opening salvo.

John Maynard Keynes would be proud. Now we need to work on Keith and Rachel.