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It's been heralded by some as a 'second stimulus', but check the numbers: it's a recipe for slow growth and high unemployment
The enthusiasm of the US business press for the compromise tax package worked out by President Obama and Republicans in Congress led to a mini-euphoria of upbeat economic projections for 2011. While the economy will do better with this tax package than if no deal were forthcoming, much of the discussion has exaggerated the potential stimulus to the economy.
First, it is important to remember that although the total package is scored as costing almost $900bn over two years, almost everything in this package simply leaves in place current tax rates and spending. The biggest portion of the tax cut continues the tax rates put in place by President Bush in 2001. The continuation of these tax cuts, including a lower estate tax rate, accounts for almost $400bn of the $900bn.
Adding in the cost of a technical fix to the Alternative Minimum Tax, which is done every year, and the continuation of a series of smaller tax breaks, brings the total to $670bn. This portion of the package buys exactly zero stimulus, since it simply amounts to continuing tax policies already in place. Had these tax breaks not continued, it would have been a drag on growth, but their continuation does not provide any additional momentum to the economy. The $60bn cost of extending unemployment insurance for another year can also be put in this category.
The only net stimulus in this package comes from replacing the $60bn Making Work Pay tax credit in 2011 with a $110bn reduction in the payroll tax and the allowance full expensing of new investment. The latter is projected to cost $55bn a year for the next two years. The full expensing in this deal replaces a provision of the 2009 stimulus package that provided for 50% expensing, which means that the net boost to the economy is half this size.
In sum, the net stimulus for the economy from this package in 2011 will be in the range of $70bn, or about 0.5% of GDP. This is not likely to provide a substantial boost to growth.
While the tax deal will be a net positive to growth for 2011, there are many other factors that are pushing in the opposite direction. First, much of the spending in the original stimulus package will be coming to an end in the first two quarters of 2011. This includes both infrastructure spending for projects that will be nearing completion, and also assistance to state governments that allowed them to better weather difficult fiscal times.
State and local governments continue to face large budget shortfalls. They are finding it increasingly difficult to paper over their budgetary gaps (most state and local governments are required to run balanced budgets), and will have to resort to further cutbacks and tax increases in the year ahead.
House prices are once again falling, with the most recent data showing an 8.5% annual rate of decline. This pace is likely to accelerate in the months ahead. The housing market had been supported through the first half of 2010 by a first-time buyers' tax credit. This had the effect of pulling many purchases forward from the second half of the year or 2011. As a result, sales have fallen by almost one third. As inventories build up again, many homeowners will be forced to make substantial price cuts to sell their houses.
Declining house prices will be another blow to consumption as homeowners recognise that they have lost even more wealth than their had previously believed. The current pace of decline implies a loss of more than $1tn in wealth over the course of a year. The actual loss of wealth could easily be twice as large if the rate of price decline accelerates.
Another factor depressing consumption is the recent bump in interest rates. While interest rates are still extremely low in both real and nominal terms, the current 10-year Treasury rate is close to a full percentage point above the lows hit in the late summer. This rise in interest rates will bring to an end the wave of mortgage refinancing that had helped to free up tens of billions of dollars for consumption. Relatively few homeowners will see much gain in refinancing at current mortgage rates.
It is also important to recognise just how slow the underlying rate of growth in the economy actually is. Most analysts have highlighted the overall GDP growth figure. But this number has been inflated over the last year by a rapid build-up of inventories. Over the last four quarters, GDP growth averaged 3.2%. However, final demand growth averaged just 1.3% over this period. In the most recent quarter, inventories were accumulating at almost the fastest rate on record. It is unlikely that the rate of inventory accumulation will accelerate further. Rather, the rate is likely to slow "“ meaning that inventories will be a net drag on growth in coming quarters.
In sum, there is every reason to expect that 2011 will be another year of weak growth, with little, if any, decline in the unemployment rate. The economy will be somewhat stronger as a result of this tax package being put in place, compared to a scenario in which nothing was done, but this is very far from the fabled "second stimulus" that some are acclaiming.
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21 December 2010 1:12PM
We'll have to wait until the next Wikileaks to find out what the Yanks are REALLY up to with this.
21 December 2010 1:13PM
I read that using the unemployment formula the Clinton used it would currently be 20%
Can anyone confirm this?
21 December 2010 1:13PM
As "growth" is inevitably unsustainable surely slow growth is what any economy can handle best.
21 December 2010 1:23PM
It's a bust!
This administration has been a fraud from day one.
The fact that Hilary Clinton is still on board proves this.
Obama was given the Nobel Peace Prize - for what? Being the first 'black' President? For what purpose?
To allow the Federal Reserve to continue printing money, the very cost of printing and making this 'money', America CANNOT AFFORD???!!!
21 December 2010 1:27PM
Isn't this a bit like being driven around in your Dad's car after consuming vast amounts of fizzy-pop.Lets just hope there are enough scheduled stops along the way, if anyone needs to be sick............all I want to know is.......................... ''are we there yet''?
21 December 2010 2:03PM
O is a creature of Wall Street which put him in the White House, squeezed out of him what they wanted in the first 90 days and then, after fixing the Nobel peace prize, strung him up to dry. The guy cannot make a decision, had never fired anyone before he became POTUS. His BIG decisions (Afghanistan, Tax breaks, Insurance) have been compromises, not forgetting the bribe to Bibi to stop building in occupied Palestine so that O could spin it as a firm decision. Gitmo is still not shut down, breaking yet another campaign promise. I voted for him. Am disgusted. Hillary would have been the lesser of the two evils. Bring back the Clinton sleaze.
21 December 2010 2:07PM
I am no economist but Dean Baker highlights what I see as a major headache over here in Ohio and that is the relationship of declining house values and debt. This is a real headache and as far as I can tell most people have done one of two things1. either walked away, often at terrible personal cost in other respects-these actions might seem like an answer but they actually represent the nuclear option in terms of personal development, health and aspirations, and set people back for years in many cases, and create huge dependency and dysfunction. Numbers are important, as there is a threshhold or critical mass to the quantity of dependent people.
2. Hung on, head in sand , hoping like hell for a fairy godmother to come along and make everything right again.
Obama has not been the Fairy Godmother but he has made some well meaning but feeble attempts to be one.
The American (consumerist) dream is all but dead, moribund for sure, but the government are trying to promote a 'cut price american dream' or 'consumerism lite' , but this process is actually just slowing the progress to some fateful time of reckoning.
There are major structural problems in the economies of the west which all these fiscal -fiddle measures cannot address, except marginally.
Hopefully this period of difficulty will permit most people to emerge reasonably intact but a major shift in political thinking will have to occur before the re-construction can occur. At the moment all I can see is political gridlock and very little genuine reform. The Tea Party and all the European Nationalism that is raising its ugly reactionary head, is the dumbfuck reaction to all this distress, but this is just creating dangers for all. We are not not in the thirties- we should know a lot more about extremism and fascism and we should be able to do the neat foot work to get out of this bind without the mindless scapegoating and violence, but damn, I think it'll be tough for a while.
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