Tax Bill Passes: An Economic Boon? - Analyst Blog

Finally, the hurdle related to sustaining the Bush-era tax cuts has come to an end. Following the clearance from the Senate on Wednesday, the $858 billion tax-cut package got the green light in the U.S. House of Representatives with 277-148 votes. The votes in favor from Democrats were 139, while the Republicans contributed 138 votes.

Now the bill just needs the president's signature. However, questions on the efficacy of the tax-cut to stimulate the economy still linger.

The immediate good news for millions of Americans is that the bill essentially gives them a pay raise. However, it will also significantly increase the nation's federal budget deficit over the next two years.

The Why and How of Tax-Cut Legislation

Retaining unemployment benefits, which expired on November 30, was part of the deal President Obama achieved from GOP leadership. Also, the estate tax will be held at 35% over the next 2 years and unemployment benefits for about 15 million jobless Americans will be stretched by another 13 months.

The legislation also enacts a reduction in Social Security taxes for almost all wage-earners for 2011. Payroll and business taxes -- as well as tax credits for students and lower-income families -- will also be retained. About 2 million unemployed people would have run out of benefits had the new tax deal not been brought into effect.

The legislation is expected to create more than $300 billion in new tax cuts for wage-earners, wealthy families and corporations. It would also maintain the 15% tax rate on most capital gains and dividends for two years.

More Cost, Less Benefit

The long-term cost of the tax-cut legislation will probably be more than the benefits. Though economic growth in the U.S. should get a boost with rising GDP from the money being pumped into the economy, this will actually be short lived.

The nation will face an even greater challenge in dealing with its large and rising public debt. There should be proactive focus on addressing the deterioration in America's budget deficit as well.  

Enough to Stimulate Job Growth?

According to Center for American Progress, the deal is expected to create about 3.1 million new jobs in total after adding up different provisions. The estimate is based on the Congressional Budget Office's estimate of one million new jobs for each 1% of GDP growth.                                     

However, based on the same assumption, the Obama administration had previously claimed that the $787 billion under the American Recovery and Reinvestment Act (ARRA) would create 3.5 million jobs. But this did not occur; the unemployment rate stands at 9.8%. And the government had not created jobs in the private sector directly by implementing rules or laws.

Though the government stimulus packages are able to increase GDP, most of the private sector firms are on the verge of recovering their financial conditions with cost savings by limiting recruitments. We don't think the new tax-cut deal will be able to address the unemployment problem to a great extent as many of the companies are still struggling with weak financials.

The recession continues to take its toll on banks. There have been 151 bank failures so far this year. With loan losses on commercial real estate on the rise, hundreds of more banks are likely to crash in the next few years.

The bank failures have resulted in a wave of consolidation in the industry. When Washington Mutual was in the red in 2008 it was deemed as the largest bank failure in the U.S. history, and was acquired by JPMorgan Chase & Co. (JPM). The other major acquirers of failed institutions since 2008 include U.S. Bancorp (USB) and BB&T Corporation (BBT).

If the current pace of consolidation continues, we will see the emergence of a handful of large banks. As a result, the overall economy will not remain unscathed and job creation will again become difficult.

The Way Ahead

The tax credits and unemployment benefits appear to be temporary. Generally, unemployment benefits are the favorites of economists as beneficiaries spend them almost immediately since they have no regular source of income. As a result, the money translates into economic activity quickly.

However, providing unemployment benefits to jobless people will not help improve the employment rate, by any means. Instead, paying people to stay out of work might create a vicious circle in the long term.

More importantly, the structure of the legislation to support the economy on a temporary basis is disappointing. The government should have additional policy efforts to address deterioration in America's budget deficit. Probably, a significant push is needed to improve America's long-term competitiveness.

 
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