One of my correspondents -- a fellow traveler in libertarian circles probably trying to get me to stop crowing about my election prediction -- wrote "So what do you think of the current 'tax deal'?"
I think the answer to that depends on whether you focus on the intent or the impact and whether your point of view is economic or political. It also depends on whether your comparison is between before the deal (BD) and after the deal (AD) or between The Deal (TD) and No Deal (ND), and, perhaps most of all, on whether your view is short term or long.
Let's dispense first with the economic impact of the tax cuts. The most favorable research (Christina Romer and spouse) seems to say that the beneficial effect of tax reductions on the production of goods and services is about $3 of GDP increase for each $1 of tax reduction and a corresponding $3 decrease for each $1 of tax increase. Of course, how it's done does determine where the gored oxen bed down for the night, but from the macro-economic point of view that hardly matters.
One way to assess the potential growth or decline is to compare BD to AD. Since the deal only cuts anew the payroll tax by about $130B next year, maybe we'll get a $400B/yr increase in GDP. Except that the extra borrowing will cancel that out if the tax reduction goes directly or indirectly to T-bills. That will happen if people do what they normally do with short term tax cuts, which is save them or pay off debt. And the one year payroll tax cut is just that: short term.
And what about TD vs. ND? Ah, well, that's why the deal will get done, isn't it? ND is a huge tax increase of $300-400B/yr, which could whack in the neighborhood of $1T or 7-ish% off the GDP. Again, the reduced borrowing shouldn't be ignored, and might completely counteract the effect on the supply side, but no one wants to chance that. Chance what, you say? Can you say Great Depression? I knew you could.
What about the extension of the unemployment insurance? The Romers' evidence is that such spending at best increases GDP a little more than dollar for dollar. The problem with this form of spending is that it denies the market a fall in the price of labor which could decrease unemployment. It probably ensures that the unemployment rate will still be near or above 9.0% this time next year as the 2012 primary season kicks off. Of course, it also further increases the deficit and hence borrowing, so after the unemployed spend their checks, the employed will squirrel away the extra income from the unemployed's purchases awaiting the postponed thaw. Again, only 13 months of extension is short term.
So much for the economic impact of the choices. The intent of the deal-makers lies entirely in the land of the political, and, indeed, a river does run through that.
The story of this river is muddier than the economic one, mostly because of the number of forks feeding into it both here and downstream. On the far bank, the left bank shall we say, the Pelosi branch enters via noisy rapids. No Deal -- the anti-Bush tax increase -- combined with a comparable amount of new spending was almost certainly their goal: more for the unions, civil servants, and other mostly non-productives. Though their huge House majority still controls, a recent landslide seems to have split its flow, diverting part of it toward the right bank.
Then there is the Reid Fork of Big Muddy. Still waters run deep here. Last month's seating of Illinois's Republican Mark Kirk (in the Barack Obama chair!) leaving Harry two votes shy of sixty seems key at first. But wait, there's more bad news than that for Harry. The rumble of the landslide was felt even here and a few of the other boulders in the Reid Fork had their support eroded and disappeared from sight. So, when 23 of Harry's closest friends -- all of whom were left in place four years ago when the ground tilted briefly to the left -- heard the roar and felt the ground shift under them, the prospects for helping the House capture all the wonderful spending-enabling tax was washed downstream.
Finally on the left there's the promontory between the two left bank forks, surmounted by a great stone visage of striking color and profile. The rumble of the landslide rocked The Face, cracking some of its aplomb away. All who see it wonder whether, in a couple of years, it might succumb to the erosion from the Pelosi fork on its left and the Reid fork on its right, crumbling and tumbling into Big Muddy below. The Face is attended by the famous sculptor Axel Rod who scurries from talk show to talk show, first announcing that a face-shoring deal must be done, then that he spoke without authority, and finally that The Deal is the best that can be done. A-Rod and others attending The Face know that if GDP declines anything like 7% over the next two years, the next landslide will make the last one look like the erosion of a beach sand castle in the few drops of a summer shower. Then, The Face and even its promontory will wash away, cutting the flow of the Reid Fork almost in half and stopping the Pelosi Fork down to a trickle.
The branches of Big Muddy that enter on the right bank are presently shrouded in fog, though the flow from them has obviously increased with the landslide. This year the rain-giving independent storm clouds in the sky shifted suddenly from the watersheds of the left bank to those of the right. Storms continue there. The promontories on the right are even less visible than the mouths of the Boehner and McConnell forks. It is known that there were frequent earthquakes in the right bank watershed all year and that hot springs began to flow a steaming brew. It cascaded down the peaks, loosing the landslide and inundating much in its path. Owing to that, it is now certain that the Boehner Fork will be at flood stage in just weeks.
In this environment, to what end could A-Rod and The Face have done otherwise? Had the Senate passed the House's bill extending the Bush tax cuts for the middle class, the President would have had to veto it! Fortunately for The Face, that was never in the forecast.
Given that the House remains in control of the Pelosi left, the vote counting for The Deal is tough. How many wacko leftists are prepared to stare down A-Rod and risk taking down The Face in 2012?
Who gets the credit if The Deal passes? Obviously A-Rod and The Face think they will, as does Charles Krauthammer. Well, in politics it's more often about the blame, and it seems to me that though those three are correct and the Right's chances are better in 2012 if The Deal fails, that's only if it fails because the Left votes it down. That's because the middle of the electorate will blame whoever killed The Deal when their taxes rise and the economy crashes. Therein lies the dilemma for the Right.
There are likely to be some votes on the Right against it in House, and a slew on the left. In combination, there may be enough to defeat it, but on the whole I think not.
What's that you say? You want to know whether The Deal is good for the country in the long run? Well, borrowing more to spend more is clearly not good. But in the long term the only way to avoid disaster is to de-authorize entitlements like twenty years of Social Security and Medicare for thirty years of work, Medicaid payments to everyone below two and a half times the poverty level, and government employee union retirements in middle age.
After all, government spending is the only real taxation -- apart from this or that few oxen gored -- because if we taxed no one at all and borrowed all it took to do the spending, the resulting inflation -- or at least the lack of deflation -- would create a tax on all the savings of everyone who had any.
My economic policy sky rotates around one star which never shifts: In the long run, government spending = taxation.
With the difference of a few gored oxen more or less, the only good outcome for the country is if the Right follows that star and works to cut government spending.
