Wall Street economists score the tax deal: $1 trillion in cost to get 0.5% increase in GDP growth in 2011

12/08/2010 1:32 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Yesterday the stock and bond markets weighed in on the proposed deal between the Obama administration and Congressional Republicans to extend the Bush administration tax cuts. Nothing unexpected there: bonds went down on the certainty that the proposal would add to the U.S. budget deficit and stocks went up on the hope that it would add to growth in the U.S. economy.

Today Wall Street economists are weighing in to put some numbers on both that deficit certainty and that growth hope.

On the debt side, estimates now are that the proposal—which this morning is drawing strong criticism both from liberals and Tea-Party conservatives such as Senator Jim DeMint (South Carolina)—would add $1 trillion to the U.S. debt over the next two years. The assumption is that none of the proposed tax cuts would be paid for by spending cuts. I think that’s a very reasonable assumption. That would put the federal budget deficit at 9% to 10% of GDP. (To benchmark that number, Spain’s budget deficit as a percentage of GDP came in at 11.1% in 2009. Spain, you might note, is at the center of the euro debt crisis.)

If this proposal passes, the United States will be the only country in the developed world that has decided not to tighten fiscal policy in 2011.

So how much extra economic growth would the United States get from piling on another $1 trillion in debt?

Economists estimate that the package, as now constructed, would add something like 0.3 to 0.5 percentage points to real U.S. economic growth in 2011.  (“Real” means discounting inflation’s contribution to growth.) And another 0.2 percentage points to growth in 2012.  JPMorgan Chase, for example, has raised its projections for U.S. economic growth to 3.5% from 3% for 2011. With the current dollar U.S. GDP at $14.8 trillion that extra half a percentage point means that the U.S. economy would add $518 billion in growth in 2011 instead of $444 billion.

Why so little from such a big addition to the deficit?

Because economists don’t project much of a boost to growth from the biggest part of the package. Extending the Bush tax cuts at a cost of $800 billion over two years, they estimate, would add about 0.2 percentage points to GDP growth in 2011.

The biggest additions to growth come from relatively modest parts of the proposal—the extension of unemployment benefits for all of 2011 and a 2% reduction in payroll taxes. Economists estimate that the modest amounts targeted at these areas, $60 billion for unemployment benefits and $120 billion for the payroll tax cuts, would have such a large influence on growth because the money goes largely to consumers who would spend all the money they receive rather than saving or investing a portion of it as top income consumers historically do with their tax cuts.

The proposal isn’t a done deal yet, given the level of opposition from left and right. But this is how Wall Street economists are scoring it now.

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