Last Friday President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, generally referred to as an extension of the “Bush era tax cuts.” Below we delineate the main provisions of this stimulus program along with the associated costs, including both additional expenditures from, and lost revenue to, the federal government, through 2012. Costs estimates are from the Congressional Budget Office:
Extension of Temporary Tax Relief: $329.57 Billion
- Maintaining Bush era income tax brackets of 10, 15, 25, 28, 33, and 35% through 2012. Taxation of qualified dividends and long-term capital gains will remain 15% for most investors, zero for those in the 10% and 15% brackets, through 2012.
- Additional items extended through 2012 include the earned income credit, relief for the marriage penalty, $1,000 per child tax credit, and a number of other tax credits.
Alternative Minimum Tax (AMT) Relief: $153.43 Billion
- The Act increases the level of income exempted from the AMT, preventing an estimated 21 million additional households from falling subject to it. The exempted amounts for individuals and married couples will be $47,450 and $72,450, respectively in 2010 and rise to $48,450 and $74,450 in 2011.
Estate Tax Relief: $32.6 Billion
- The estate tax was scheduled to effectively be eliminated in 2010, but included a carry over of basis. It was then scheduled to adjust back to a tax rate of 55% on estates in excess of $1 million in 2011. The law institutes a 35% tax on estates in excess of $5 million from 2011 through 2012. Executors of estates in which the decedent died in 2010 may choose to be taxed based on the new 35% rate and $5 million exemption with a stepped up basis or have no estate tax but carry over the basis from the decedent.
Extension of Federal Unemployment Benefits: $56.16 Billion
- The legislation continues the extension of federal emergency unemployment benefits for up to 13 months. Note that this does not extend benefits for those that have, or are about to, max out of their extended benefits. It simply continues federal financing of the extension of benefits currently in place, i.e. the maximum period over which benefits can be claimed remains in place.
Extension of Small Business Jobs and Credit Act of 2010: $113.6 Billion
- The Act allows businesses to deduct 100% of capital expenses in 2011, up from 50% in 2010, returning to 50% in 2012.
A one-year, 2 percentage point reduction in employee FICA payroll tax: $111.7 Billion
- This reduces the social security tax paid by employees from 6.2% to 4.2% for 2011. The rate declines from 12.4% to 10.4% for self-employed individuals.
Without the stimulus the US economy likely would have grown 2-3% in 2011, with risks skewed to the lower end of that range. With the stimulus, US GDP will likely expand a much more robust 3-4% next year. Yet, not including TARP, this legislation is the third fiscal stimulus plan in as many years and the second enormous one in the last two years. The American Recovery and Reinvestment Act of 2009 was a $787 billion dollar fiscal stimulus while the plan outlined above is slightly larger at a cost of $797 billion over the next two years (the total reaches $857.8 billion including costs expected to be incurred between 2013 and 2020). Individually, each equates to approximately 5.5% of GDP. While there are merits and pitfalls to both, the US economy, still mired in recession, was badly in need of fiscal stimulus in the first quarter of 2009. While the recovery remains far from robust, we are concerned with the scope of the current legislation, coming six quarters into the recovery and with the nation struggling to absorb the deficits bought on by the crisis and the government’s response to it. While the stimulus provides a boost to near-term growth, it fails to tackle the structural headwinds facing our economy. It does not address the high cost and relatively poor performance of our educational system. Nor does it tackle the solvency of social security, our lack of competitiveness in manufacturing and the resultant imbalance between the manufacturing and services sectors, underinvestment in infrastructure and misallocation of resources. These are among the most pressing issues impinging upon our competitiveness in the world economy. Additionally, this boost to near-term growth has come at the expense of fiscal prudence. The actual cost of the stimulus will be dependent upon the degree to which it boosts economic growth and the extent to which that growth becomes self-sustaining. Yet with no offsetting fiscal restraint, it will undoubtedly add to the deficit.
The stimulus will provide the economy with a significant lift in 2011, which is likely to raise the value of risky assets. This in turn, is likely to provide a wealth effect that is likely to lift GDP again, but more modestly, in 2012, yet nothing has been done to alter our competitive standing in the world economy. As such, by late 2012 or early 2013, we will likely be faced with moderate GDP growth and a massive fiscal deficit. Additionally, the US will likely face a lack of confidence among its trading partners and global market participants with respect to its willingness to accept fiscal restraint. As such, the recently enacted stimulus is much like giving a heart attack patient a shot of adrenaline on the way to the hospital, i.e. it’s a short-term fix for a long-term problem. Addressing the structural imbalances facing the US economy will require something more akin to open-heart surgery. To date, neither doctor nor patient appears to realize the gravity of the situation.