Bulls Take Note: Tax Deal Won’t Stimulate Much

There is much less stimulus than touted in the press. Political posturing has resulted in poor policy. Funny to watch the erstwhile critics of the Bush tax cuts turn into Reaganesque supply-siders. They are besides themselves crowing about how a tax cut will stimulate the economy. Where were they when Chirstina Romer was still Obama’s head of economic advisors? Her seminal studies showed properly-structured tax cuts had 3x the stimulative impact as increased spending. Instead, they pushed through the Stimulus which they now admit was poorly done.

The tax deal actually creates little incremental reduction in taxes, since it mostly continues what is already in place. Put simply, not letting the Bush tax cuts lapse is NOT stimulative; it just avoids a drag on the recovery. What is actually new is relatively modest in size. If you review this chart from Megan McArdle at The Atlantic, the first three items are continuations; the last four are incremental:

In addition, the highlight of the deal, the payroll tax cut, is poorly structured to have the right type of impact. What the economy needs is business investment that leads to new jobs; this just continues demand-side stimulus of the sort which has kicked the can down the road for the past two years rather than lead to a recovery. Worse, it is temporary, and going back to Milton Friedman, it is well known that temporary tax cuts have no lasting impact.

The politicization extends to the CBO, which normally does sound work; their assessment of the tax deal is being criticized by center-left commentators like Megan, who notes this:

According to the CBO, the low estimate is that temporarily extending the Bush tax cuts for the middle class aren’t very stimulative, while extending the tax cuts for those who make over $250,000 doesn’t show up at all; in the high estimate, extending the tax cuts for incomes above $250,000 reduces employment by about a tenth of one percent, while extending the tax cuts for incomes below $250,000 lowers it by about half a percent.

It’s true that there is some differential effect. But most of that figure is not driven by the fact that wealthy save their tax cuts, while the middle class spend them; it’s driven by the fact that the tax cuts for incomes below $250,000 are much larger, in terms of the federal budget, than tax cuts for higher incomes.

According to CNN, the two-year cost of the tax cuts for high earners will be about $75 billion, while the estimated cost of the cuts for incomes below $250,000 is about $310 billion, or four times larger.

Consider this finalirony: as we head into the 2012 elections, the debate will be about supply-side tax cuts, not demand-side stimulus – the Republican playbook, not the stuff of the Democrats. Worse for the Demos, an Obamcare tax increase (the medicare 3.8% surcharge) will kick in in 2013 and have to be dealt with.

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About Duncan Davidson 228 Articles

Affiliation: NetService Ventures

Duncan is an advisor to NetService Ventures, where he focuses on digital media and the mobile Internet.

Previously he was at four start-ups: Xumii, a mobile social service based on a Social Addressbook; SkyPilot Networks, the performance leader of wireless mesh systems for last-mile access, where he was the founding CEO; Covad Communications (Amex: DVW, $9B market cap at the peak), the leading independent DSL access provider, where he was the founding Chairman; InterTrust Technologies ($9B market cap at the peak), the pioneer in digital rights management technologies, now owned by Sony and Philips, where he was SVP Business Development and the pitchman for the IPO.

Before these ventures, Duncan was a partner at Cambridge Venture Partners, an early-stage venture firm, and managing partner of Gemini McKenna, a joint venture between Regis McKenna's marketing firm and Gemini Consulting, the global management consulting arm of Cap Gemini.

He serves on the board or is an adviser to Aggregate Knowledge (content discovery), Livescribe (digital pen), AllVoices (citizen journalism), Xumii (mobile social addressbook), Verismo (Internet settop box), and Widevine (DRM for IPTV).

Visit: Duncan Davidson's Blogs

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