Tax Cuts Receive New Emphasis—and Some Criticism—in Stimulus Debate

Obama has emphasized tax relief to assuage skeptical Republicans, but some economists are wary.

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Amid worries about skyrocketing joblessness, Senate Democrats convened a rare weekend meeting to hash out President-elect Barack Obama's $775 billion economic stimulus proposal, whose tax-relief provisions have left some Democrats skeptical.

Much of the early debate over the stimulus focused on infrastructure spending, but the tax measures have gained prominence in recent days, in part because they are viewed as a means to woo Republicans who have raised fears about runaway spending in the stimulus plan.

But a number of economists are critical of the just-floated Obama tax proposals, calling them poorly designed, potentially ineffective, and likely to trigger what one called "an administrative nightmare."

Obama and key advisers have tried to sell their stimulus—still a work in progress—all week. Aides say tax relief could total about $300 billion, or roughly 40 percent of the package. But at Friday's news that unemployment had soared to 7.2 percent, a 16-year high, countervailing forces roiled Democrats. Some want quick action. Others warn against becoming Obama's rubber stamp.

Only broad outlines of the nascent tax-relief measures have been made public. The centerpiece is a $500 tax cut for middle-class workers or $1,000 for families. Obama says 95 percent of working families would get help.

This relief would not be in the form of a rebate check, top Democrats say. It reportedly would be put back in the hands of workers by lowering federal withholding taxes in future paychecks. Last year's $600 stimulus rebate checks were considered largely a bust, since many recipients either saved the windfall or paid credit-card bills instead of engaging in new spending, as the rebates' advocates had hoped.

Another highlight of the Obama proposals is a tax credit, reportedly worth $3,000, to "incentivize" employers who retain or hire more workers.

One influential Senate Democrat, Kent Conrad of North Dakota, chair of the Budget Committee, has said the Great Depression proved that "marginal incentives," such as a $3,000 credit, don't work well because employers aren't likely to hire more people if there's not demand for their products.

Others are blunter. Columbia University's Joseph Stiglitz, a Nobel Prize-winning economist, said rewarding employers who retain or hire more employees could result in an "administrative nightmare" in light of the regular turnover in the workforce.

Stiglitz also took issue with a third tax-relief measure Obama has floated that would extend for businesses the so-called loss carry-back provision to allow them to extend net operating losses back five years (instead of the usual two), thereby recouping some taxes paid earlier. He said that such a change would reward failing firms—not dynamic ones—and might translate into a new bailout for the financial sector. "A hidden bailout," he dubbed it.

Bill Gale, an economist who is codirector of the Tax Policy Center run by the Brookings Institution and the Urban Institute, said some of the tax measures "are just extremely poorly designed." He supports a spending infusion—not tax relief—saying it would yield a larger bang for every buck spent. "Businesses and households are going to be reluctant to spend out their full tax cuts," he said. "People have had their wits scared out of them—and are trying to retrench as fast as they can."

The top House Republican, Ohio's John Boehner, renewed his support Friday for major tax relief in a stimulus bill. "America cannot buy its way to prosperity with more government spending," he said. Boehner added that he was pleased that Obama "agrees with Republicans that substantial tax relief must be an important component of the final bill Congress sends to his desk."

Another Obama provision, aimed at small businesses, would allow them deduct up to $250,000 in business machinery and equipment in 2009 and 2010, an increase from current levels. Another measure would let businesses accelerate depreciation of machinery and equipment. Obama aides said more initiatives are coming, including tax relief to create jobs in the energy sector.