On the Tax Cut Deal

Greg Mankiw likes it

Howard Gleckman is livid.

As David Leonhardt suggests, it is perhaps best understood as a “second stimulus,” or rather a third if we include the 2008 fiscal stimulus measure. (Or fourth if we include deficit spending and public sector job creation at the state and local levels throughout the Bush years.) 

Ezra Klein has been highlighting the unemployment insurance extension, the extension of various tax provisions associated with the ARRA fiscal stimulus, etc., citing Bob Greenstein of CBPP:

If you’re worried about stimulus, joblessness and the working poor, this is probably a better deal than you thought you were going to get. “It’s a bigger deal than anyone expected,” says Bob Greenstein, president of the Center on Budget and Policy Priorities. “Both sides gave more expected and both sides got more than expected.” The White House walked out of the negotiations with more stimulus than anyone had seen coming. But they did it in a way that made their staunchest allies feel left behind, and in many cases, utterly betrayed.

Ezra also thinks it’s a promising sign that the White House can cut deals with congressional Republicans.

I basically think the deal was a net loss. It was a political win for Republicans, but not, in my view, a substantive win for fiscal conservatives. I’ve argued for temporary extension of all of the 2001 and 2003 tax cuts, yet I strongly think that a 3-year extension was preferable to a 2-year extension, as presidential politics will get in the way of a 2012 debate over the future of the tax code. Glenn Hubbard captures my sentiments on the broader question of where the tax reform debate should go.

I’ll also note that the best empirical evidence we have suggests that the tax provisions of ARRA, including the Making Work Pay tax credit, did not work as intended, as my Economics 21 colleagues recently observed:

The researchers [Matthew Shapiro, Claudia Sahm, and Joel Slemrod] find that in response to the one-time tax cuts in 2008, only 25% of households reported higher spending. This result is consistent with a large body of economic literature that suggests households smooth out their consumption over time, and so an unexpected windfall only slightly raises current levels of spending.

More surprising is the analysis of the tax cuts associated with the 2009 ARRA stimulus. These took effect through the form of reduced federal tax withholding on payrolls, and were widely expected to be more effective than one-time tax cuts in elevating aggregate spending. Yet the authors find that a mere 13% of households reported higher levels of spending due to the tax cuts.

The authors suggest that households that anticipate a decline in household income are saving the proceeds, which makes intuitive sense.

I’m glad to see that the Making Work Pay tax credit has been abandoned, though its motivation was sound. Assuming we’re not looking for a huge short-term stimulative effect, we can at least say that the extension of most of the ARRA tax provisions and the payroll tax cut will help middle-income households repair their balance sheets, and that’s certainly something. But let’s be cautious in advancing claims about the “jobs multiplier” we associate with these targeted tax cuts.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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