Which stimulus is better: tax cuts or spending?

Yes, President Obama’s economic recovery bill would shower billions in government spending on everything from rural Internet service to inner-city schools. But as the Senate debates the stimulus bill, lawmakers increasingly are focused on another section of the plan: its tax cuts.

Republicans are pushing to reorient the legislation as much as possible to tax reduction. They’ve already convinced the Democratic leadership to add a $71 billion provision that would soften the blow of the alternative minimum tax, a levy that was originally intended to affect the wealthy, but now hits many middle-class families.

It’s true that tax cuts might boost the economy more quickly than spending, say many economists. But there is debate as to whether their effect is as lasting or effective per dollar as direct government outlays.

The irony is that the biggest cuts in Mr. Obama’s plan, which put money directly into taxpayer pockets, may not be particularly efficient at jolting the economy back to life. That’s because people may choose to save a portion of the cash.

“I think we ought to be considering a range of tax cuts that are directly linked to spending, or household investment,” says William Galston, a senior fellow in governance studies at the Brookings Institution in Washington.

Obama to turn up heat

President Obama on Tuesday turned up his efforts to push the stimulus bill through the Senate. He planned a series of broadcast media appearances to argue for the necessity of quick passage – and he told Democratic Senate leaders to take out some of the controversial spending provisions in the bill and to increase some of its tax credits.

Among the changes Democrats might accept is a GOP proposal to double a tax credit already in the bill for the purchase of a new home, from $7,500 to $15,000.

Mid-February is deadline

Obama has set a deadline of mid-February for the legislation’s passage. He hopes to pick up enough Republican support so that he can argue that he has fulfilled his pledge to work on important issues in a bipartisan manner.

“What we can’t do is let modest differences get in the way” of the bill, said Obama on Monday.

GOP senators, for their part, say their goal is to change the bill, not block it.

“Nobody that I know of is trying to keep a package from passing,” said Sen. Mitch McConnell (R) of Kentucky, the Senate Republican leader.

As the recovery legislation now stands, tax cuts account for about $252 billion of its $885 billion total cost, according to an analysis of the Senate bill released by the Congressional Budget Office on Monday.

A tax cut for all workers

Of this, $142 billion would go for Obama’s “Making Work Pay” tax credit for individuals. This credit – up to $500 a year for individuals and $1,000 for two-income couples – would fulfill Obama’s campaign pledge of tax relief for low- and middle-income workers. The full amount would be limited to individuals who make $75,000 or less and couples making $150,000 or less.

As a stimulus effort, this tax credit suffers from the fact that recipients could choose to save it, rather than spend it. That is a classic aspect of tax cuts in general, CBO director Douglas Elmendorf said recently.

“Most economists judge that a dollar of government outlay has a larger effect on [gross domestic product] than a dollar of tax cuts for the simple reason that the dollar of extra government spending goes directly to demand for goods and services,” said Mr. Elmendorf on Jan. 27.

On the other hand, the Making Work Pay credit is small, about $10 a week for the average taxpayer, and thus might be more likely to be spent, according to an analysis of the stimulus plan tax cuts by the Urban Institute-Brookings Tax Policy Center.

As to the credit’s stimulative effect, the Tax Policy Center analysis gives it a B-plus.

“The proposal gets high marks for timeliness,” says the analysis.

Other individual income-tax provisions contained in the Senate version of the stimulus package include an increase in the earned income-tax credit, estimated to cost $4.7 billion; a $13 billion education tax credit; the first-time home buyer credit, which would cost at least $2.6 billion; and the $70 billion AMT adjustment.

The Tax Policy Center rates the change in the AMT a D-minus in terms of its stimulus effect.

“Neither timely nor targeted; makes no sense as economic stimulus,” says the analysis.

Breaks for businesses, too

The stimulus package also includes general business tax breaks that would total more than $35 billion.
Small businesses would be able to increase the dollar amount of expenses they could write off from $125,000 to $250,000 for 2009 and 2010, for instance. Businesses would have an increased ability to apply recent losses against past and future tax bills.

The Senate bill also includes an $11 billion provision that would make it easier for businesses to claim tax credits for investing in renewable-energy equipment. The version of the legislation passed by the House doesn’t have this change.

– Associated Press material was used in this report.