Austerity delayed

Economics

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Fiscal policy

Austerity delayed

by G.I. | WASHINGTON

FOR a brief interlude after the mid-terms Americans seemed seduced by the siren song of Germanic austerity. Feeble economy or no, the talk was all of rising taxes, pay freezes and spending cuts.

Austerity will have to wait for its turn in the limelight. On Monday Barack Obama and Republican and Democratic leaders in Congress struck a deal on a massive new package of stimulus and tax cut extensions, worth some $800 billion (around 5% of GDP). Though it must still pass the parties’ respective caucuses, this is good news for the economy: the prospect of inadvertent fiscal tightening was the biggest cloud hanging over the 2011 outlook. But it’s a political setback for Mr Obama who gave up more than Republicans did, and worse news for those who had hoped such stimulus would be coupled with a serious medium-term deficit reduction package.

The package comes in two parts. The first is an extension of all of George Bush’s tax cuts for the next two years. Mr Obama acquiesced to an extension for the upper 2%, bowing to the reality that he did not have 60 votes in the Senate to extend only the cuts for the lower 98%. Tax credits for child care, education and for low-income wage earners are also extended.

The second part is an injection of short-term fiscal steroids: a two-percentage point cut in the Social Security payroll tax for workers for one year, worth $120 billion (that’s double what Mr Obama’s “making work pay” credit was worth), one year of complete expensing of business equipment, worth $200 billion, and a 13-month extension of emergency unemployment insurance benefits.

A senior administration official says the result is even more stimulus for the economy than Mr Obama had planned in last February’s budget. Fiscal policy goes from being a source of drag on the economy to a source of stimulus next year, he figures. “This is a much better deal for the near term economy than what we put in the budget, and what passed the House last week. The combination of unemployment insurance, business expensing, the payroll tax holiday and [refundable tax credits] is very high impact.”

While the stimulative boost is probably worth some $800 billion, or roughly 5% of GDP, the 10-year cost is lower largely because tax deferred by accelerated business investment expensing will eventually be paid.

Economists had generally projected growth next year at only 2.5%, and the biggest risk to that already tepid outlook had been the prospect that some or all of Mr Bush’s tax cuts would expire at the same time as much of Mr Obama’s temporary stimulus. Tonight’s deal is likely to lead to a round of upward revisions. Last week Goldman Sachs raised its forecast for growth next year in part because of the prospect of a deal on taxes.

Politically, it’s hard to see this as anything but a loss for Mr Obama. First, he vowed not to extend the tax cuts for the rich, then sought to extend them only temporarily while making the rest permanent. Republicans forced him to retreat on both counts. They also put all other legislation, including the START nuclear arms treaty, on hold until the tax issue was finished. (The administration official disputed this interpretation, noting that a stronger economy in the next year or two works against Republican hopes of denying Mr Obama a second term.) Mr Obama’s remarks last night had not a single kind word for Republicans, with every concession to their position acknowledged through clenched teeth.

It is also a depressing reminder that for all the talk of a new era of austerity in America, politicians here still find it easier to give money away than to take it back. To the extent that Mr Obama is able to spin this as a victory, it's through his use of tax cuts for the wealthy as a means to obtain bigger short-term stimulus. Thoughtful economists, including those advising Mr Obama, think the ideal fiscal package would couple short-term stimulus with medium-term consolidation. We got the first in spades tonight, but there is still no sign of the second. The cold shoulder that most elected officials gave to the Simpson-Bowles deficit commission last week is evidence enough that austerity’s appeal remains mostly theoretical.

Optimists think there might be an opportunity to hammer out some sort of medium-term package in the coming months: Mr Obama’s state-of-the-union speech, his budget in February, and the imminent need to raise the statutory ceiling on how much debt the Treasury may issue could all provide the setting. There is potential common ground between Republicans and Mr Obama on tax reform, Social Security, and on rules limiting discretionary spending. But administering such bitter medicine usually requires a helping of sugar, and now that both Mr Obama’s and the Republicans’ near-term priorities have been satisfied, most of the sugar is gone.

A debt crisis has never been likely for America, much less imminent. But it looks to me that while the odds remain low, they went up tonight. By putting off the expiration of the tax cuts to the month after the next presidential election, the negotiators have again set us up for another nail-biting collision between the economic and political calendars. Hopefully the markets will remain as tolerant as they have so far.