Tax-cut plan digs deeper deficit hole

The tax-cut deal President Obama struck with congressional Republicans reflects an enduring political reality: Forced to choose, Washington’s leaders kick long-term problems down the road.

FOR THE RECORD:
Tax cuts: A Dec. 9 article in Section A about how the extension of tax cuts could affect the federal budget deficit said that temporary tax credits or deductions Congress often extends included mortgage interest. In fact, it is the deduction for mortgage insurance that is commonly extended. —

The agreement would add a staggering $700 billion to the federal budget deficit in the next two years alone, and the prospects for tax cuts and their negative consequences for the deficit could continue for years. Just last week, a bipartisan commission said that severe federal spending cutbacks were needed to avert a potentially dangerous surge in the deficit.

The Senate will launch the tax-cut debate and could begin voting this week, Majority Leader Harry Reid (D-Nev.) said Wednesday. Democrats remain uneasy about the deal and want an opportunity to amend it — a prospect that remains uncertain because changes could kill the agreement hammered out at the White House.

“There’s still a lot of concern among a lot of Democrats,” said Sen. Tom Harkin (D- Iowa).

Lawmakers are under pressure to act quickly. The Bush-era tax cuts expire at the end of the month, and some programs that extend unemployment benefits are ending during the month. The deal Obama announced Monday would not only continue tax cuts for two years but also fund those jobless programs through the end of next year.

For the second day in a row, administration officials, including Vice President Joe Biden, visited Capitol Hill to press the economic case for the tax package as Democrats met behind closed doors to assess their options.

“Failure to pass this bill in the next couple of weeks would materially increase the risk that the economy would stall out and we would have a double-dip” recession, warned Lawrence Summers, director of the National Economic Council.

But outside analysts were skeptical about the long-term outlook.

“The ‘compromise’ shows that policymakers, for the most part, have almost no intention of actively pursuing fiscal austerity, in our view,” economists at Bank of America Merrill Lynch said this week.

“Each side is basically getting what it wants. This may aid the recovery in the short term, but raises concerns over the nation’s long-run fiscal sustainability,” they said.

While supporters argued that the deficit-busting tax cuts were authorized only on a temporary basis, economists noted that it’s common for dozens of special tax provisions to reach expiration dates every year, only to be quietly extended — sometimes at the behest of affected interest groups and sometimes because large segments of the public have come to expect them.

These include tax credits or deductions for research and development, mortgage interest and education expenses.

“It’s absolutely a worry,” said Roberton Williams, a senior fellow at the nonpartisan Tax Policy Center. “If you just go by history, these things come up every year and Congress renews them every year.”

Obama has said repeatedly that the country cannot afford to continue the Bush administration’s income tax cuts for the wealthy, but in the end, the president agreed to keep those cuts going — as well as those for all Americans — for an additional two years.

In exchange, Republicans agreed to support a 13-month extension of aid for long-term unemployed workers and a one-year reduction in Social Security payroll taxes.

The cut in payroll tax deductions will cost the government $120 billion. It effectively translates into a 2% pay raise for most U.S. workers: A worker with a typical taxable income of $40,000 would take home $800 more over the course of the year.

The White House said the payroll tax cut wouldn’t hurt the Social Security fund because the deal would provide a transfer of general revenue into the fund for the elderly. But that simply means the government will be moving money from the left hand to the right — money it gets only by deficit spending.

“It’s all going to be put on the government credit card,” Williams said.

Moreover, though touted as a one-year measure, the payroll tax cuts will come up for renewal as the 2012 presidential election campaign shifts into high gear.

“It’s very hard to imagine either party [agreeing] to increase payroll taxes at the beginning of an election year,” said Robert J. Shapiro, an economic advisor to President Clinton and chairman of consulting firm Sonecon Inc.

More likely, he said, the payroll tax would revert to the current 6.2% rate only gradually over a number of years.

As for renewing extended unemployment benefits when they expire next year, he said, “that’ll be a fight.”

Underlying Obama’s deal with Republican leaders is the belief that the economy and the job market, with unemployment near 10%, need further federal help.

The payroll tax cuts, extended jobless benefits and other programs for middle-class Americans, such as credit for college tuition, would amount to a new stimulus of around $200 billion — about one-fourth of Obama’s Recovery Act package passed early last year.

The plan is “crucial to reducing the deficit over the medium to long run, to reducing poverty over the medium to long run and to enabling the nation to afford all of its other objectives,” Summers said. “Much as we regret the elements in it that do not seem to us to be prudent use of public resources, on balance the benefit to the economy make this very worthwhile.”

Private economists widely agree that the tax proposal would boost consumer spending and raise economic growth next year — in the range of 0.5% to a full percentage point. The upper end of that forecast, if it panned out, would be significant, given that the economy is projected to grow about 2.5% this year.

By one rule of thumb, a full percentage-point increase in economic output would translate into 1 million more jobs and nearly guarantee that the economy would not fall back into recession, a persistent worry until recently.

“I think we would have made our way through without an additional stimulus, but this seals the deal,” said Mark Zandi, chief economist at Moody’s Analytics, which sees unemployment dropping to 8.6% next year as opposed to staying at near 10% without the tax package.

Wall Street analysts noted that longer-term interest rates have risen sharply higher this week, reflecting the greater optimism about economic growth in 2011.

The 10-year Treasury note yield, a benchmark for mortgage rates, jumped to a five-month high of 3.24% Wednesday from 3.16% Tuesday and 2.94% Monday, a huge move in the space of three days. But expectations that the budget deficit will balloon further also have helped push up rates.

In considering the nation’s bulging deficits, many economists and policymakers, including Summers and Federal Reserve Chairman Ben S. Bernanke, stress the need to distinguish between short-term needs and longer-range risks.

“There’s very little choice in the short term but to have measures like this which, in the short term, add to the debt,” said Sen. Kent Conrad (D-N.D.), chairman of the Senate Budget Committee.

“To me the next question is: Where is the plan to deal with the long term?” he said. “Short term, we need additional lift to this economy, additional liquidity. Medium and longer term, we need to pivot and have a plan to reduce the deficit and debt.”

But the agreement between Obama and GOP lawmakers, who had been adamant about the need to reduce the deficit while preserving all the Bush-era tax cuts, raised concerns about whether Washington would make that pivot in the future.

don.lee@latimes.com

Times staff writers Lisa Mascaro and Peter Nicholas in Washington and Tom Petruno in Los Angeles contributed to this report.