The Tax Deal

WE'll see how this plays out in the months to come.



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December 7, 2010, 7:45 am
PAUL KRUGMAN

The Deal
So the tax deal is out. Obama extracted some concessions, with the big surprise being a payroll tax cut. How much better do these concessions make the thing?

Well, for starters we have the two-year extension of the Bush tax cuts. As I pointed out yesterday, the CBO estimated that such an extension would reduce unemployment relative to what it would have been otherwise by 0.1 to 0.3 percentage points in 2011, twice that in 2012.

To this, the deal added $120 billion in a payroll tax cut; $56 billion in extended unemployment benefits; about $40 billion in extension of other tax credit. Also, expensing of business investment.

I’d discount the last item: we’re awash in excess capacity, and likely to stay that way for years, so I don’t expect business investment to be noticeably affected by tax breaks that give an incentive to move spending up in time. The rest is about $220 billion, or about 0.75 percent of GDP over the two-year period. What’s the multiplier on that? Pretty high on UI, which will get spent; less on the rest. Overall, probably less than 1. So let’s say that this raises GDP by 0.7 percent relative to otherwise; rule of thumb is that one point on GDP is half a point on unemployment, so add 0.35 points to the CBO numbers.

That’s a two-year average; what about timing? Both the payroll tax break and the unemployment extension are for the first year only. So, a bigger boost next year, fading out in 2012. Since all the evidence says that elections depend on the rate of change of unemployment, not its level, this is actually bad news for Obama: he’s setting himself up for an economic stall in the months leading into the 2012 election.

Oh, and he’s overpromising again:

“It’s not perfect, but this compromise is an essential step on the road to recovery,” Mr. Obama said. “It will stop middle-class taxes from going up. It will spur our private sector to create millions of new jobs, and add momentum that our economy badly needs.”

Millions of new jobs? Millions? Not by my arithmetic.

So, was this worth it? I’d still say no, although it’s better than what I expected over the weekend. It still greatly increases the chances of the Bush tax cuts being made permanent — especially because the front-loading of the stimulative stuff actually worsens Obama’s 2012 electoral prospects.

Overall, enough sweetener has been added to diminish, but not eliminate, the bitterness of the disappointment.