There are two ways of looking at the tax-and-unemployment-benefits-extension deal struck between President Barack Obama and congressional Republicans.
If you are an optimist, it is the ‘least bad’ deal that could be struck in the current political climate and is better than doing nothing, which would both slow the economy and worsen the plight of the unemployed.
If you are a pessimist, you might deem it a bad bargain. It dramatically worsens the deficit and provides little stimulus to investment, consumption or employment.
From both sides, views are driven as much by general political beliefs as from any widely accepted economic principle. Indeed, this is a classic example of a situation where neither side has any monopoly on economic wisdom. But there is a broad, if not universal, consensus among economists on some issues taken individually:
Tax rates. No school of economic thought, liberal or conservative, advocates raising tax rates when an economy is in the doldrums. And Keynesian economists argue that taxes should be lowered as a short-term spur to output and employment. So extending existing tax rates for all avoids the braking effect that could come from a tax increase. It helps maintain consumption at a time when overall demand in the economy is slack. Including the highest-income taxpayers, however, does so at a high cost in forgone income.
Self-described supply-siders argue that greater investment by the wealthy will so spur output and hiring that there will be no such loss of revenues. Economic theory and the history of the last 30 years provide little support for that position, but it persists, nonetheless.
Estate taxes. The fact that estate taxes were reinstated at a lower rate than before seems a deal-breaker for some congressional Democrats, but not necessarily for economists in their party. Estate taxes have what economists call a high “excess burden.” That is, they cost society a lot relative to the revenues they raise for government. That is because resources get wasted in all the gyrations people exposed to the tax go through to minimize their liability. Many economists would be happy to see estate and inheritance taxes eliminated permanently if remaining taxes, such as individual income taxes, were raised to make up the revenue shortfall. But it is better to tax estates than to further add to deficits.
Liberals see estate taxes as a measure to reduce income inequality and reduce concentrations of wealth. Conservatives see them as strangling savings and investment. Research on the federal estate tax in our country over the last century demonstrates that it is neither an important factor in equalizing income distribution nor a significant drag on economic growth. This argument is largely about symbolism, not substance.
Payroll taxes. Reducing Social Security taxes by 2 percentage points for one year is a Keynesian measure to spur consumption, and tangentially, hiring. Critics already are carping over the detail that the reduction is on the employee’s half of FICA withholdings, rather than the employer’s portion. They argue that if employers saw a reduction in payroll costs they would have a greater incentive to hire more employees.
Economists generally agree that, over the long run, the matched 6.2 percent Social Security taxes on employee and employer amounts to a 12.4 percent tax on wages and how it is split means little. Labor markets, wage rates and hiring all adjust to the total tax.
Unemployment benefits. Extending unemployment benefits gets money to people who are likely to spend it. But elementary economic theory also teaches that lowering the cost of being out of a job reduces motivation for people to search for work. The extent to which this is true in real life has been argued over for 70 years. Liberals see it as a minor factor, conservatives as an important one. Don’t expect this period in our history to settle the question.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.