Obama eyes the familiar: tax cuts

He’s likely to propose a credit of $500 per person to help stimulate the economy.

By , Staff writer

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    President-elect Barack Obama, Congressional leaders Nancy Pelosi and Harry Reid in Washington on Monday.
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American presidents’ love affair with tax cuts dates back at least to Ronald Reagan, who used an ax to cut rates and stimulate the economy. President Bush tried a different tax gambit last year: mailing out rebate checks – an effort that mostly seemed to boost the economy for a quarter.

Now, President-elect Obama is planning his own version of a tax cut: a taxpayer credit aimed mainly at Middle America, with some aimed at helping business.

But would it work? And does it make a difference if the cut is temporary or permanent?

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Congress will be considering these questions when it takes up Mr. Obama’s expected proposal, which would give a tax credit of $500 per person or $1,000 per married couple (for those with incomes under $200,000).

The way some economists see it, the duration of a tax cut does matter: If Americans think it’s temporary, they tend to save the money or pay down debt. If they think a cut is there to stay, they seem more inclined to spend it.

“If people believe the tax cut is a permanent arrangement, they have the confidence to go forward and spend it. But if they think it’s a short-term event, they bank it,” says James Miller III, who was director of the Office of Management and Budget in the Reagan White House.

During his presidential campaign, Obama indicated he wanted to make a $500 tax credit a permanent feature, or at least in the budget for the next 10 years. But there is one problem with writing into law hundreds of billions of dollars of tax cuts: the soaring budget deficit.

“We’re running these massive deficits, and we can’t afford $800 billion-plus in additional tax credits over the next 10 years,” says Leonard Burman, director of the tax policy center at the Urban Institute in Washington. “On the one hand, a permanent cut is better than a temporary cut, although temporary tax cuts have a habit of becoming permanent anyway,” he adds.

In handing out rebate checks last year, Congress set an income limit of $75,000 for an individual and $150,000 for a couple. Although lawmakers are likely to set income limits again this year, Mark Zandi of Moody’s Economy.com thinks that would be a mistake.

“The most effective is if it goes to everyone,” says Mr. Zandi, who formerly was in favor of income limits. “The reason the checks this [past] spring were not as effective as expected was that people with higher income levels pulled back their spending more.”

Some Republicans in Washington agree with Zandi’s assessment. On Monday, Sen. Charles Grassley (R) of Iowa, the ranking member of the Committee on Finance, said in a statement, “We ought to be inclusive rather than exclusive to ensure that the maximum stimulus occurs.”

Money just for lower-income people?

Other economists believe that tax credits are best targeted to lower- to middle-income earners, even those who receive the Earned Income Tax Credit. The argument is they spend the money immediately on basics such as food or lodging.

This would be the case for Carlton Clark, who lives on the streets in midtown Manhattan. Jobless, he didn’t get last year’s stimulus. If he were to receive $500 this year, he says, “I’d try to get me a room.”

He knows a place in Brooklyn that rents for $100 a week. “At least I’d get in a bed for a month and a half,” he says.

In evaluating the 2008 stimulus package, a survey by the University of Michigan found that consumers spent about a third of the rebate money. “It’s not a trivial amount, but the so-called multiplier effect on the economy is not very large if consumers only spent a third,” says Joel Slemrod, director of tax policy research at the university. “However, even if it was a third, it just made the economy grow for one quarter and then made the growth rate lower in the next quarter.”

Last year, Mr. Slemrod says, many consumers opted to save the money or use it to pay down debt. “I have no reason to think it will be any better this year. And in fact, it might be worse because people on the whole are looking to cushion their assets or pay down debt even more so than nine months ago,” he says.

One of those people would be Daniel Edgell, a project architect in Rochester, N.Y. He’s “pretty certain” he would save the money as he did last spring, when he and his wife, a student, kept all their $1,200 from the stimulus.

Mr. Edgell’s goal is to found his own architecture firm. “I’m not really convinced another stimulus is going to do anybody any good,” he writes in an e-mail, although he indicates he wouldn’t decline the money.

One idea: pay off debt, spend later

Still, Zandi thinks the rebate checks prompted spending, even if Americans used the money to pay down debt, because it gave people the opportunity to spend more later. This is how Jim Kernan, a Philadelphia mortgage adviser, figures he would use $500.

“If I were to get another stimulus check, I would give thought to paying down debt I currently have or make sure I spend it on either a product made in the US or a service I would need, such as some electrical work in my home,” says Mr. Kernan in an e-mail. “If we are getting this money, I want to make sure I’m doing my part to put it back into the US economy.”

Economists are even less certain about the effectiveness of tax breaks for business. One of the expected proposals would allow companies to carry back their current losses to offset taxes they paid over the past five years.

“It probably won’t do much good,” says Mr. Burman of the Urban Institute. “Those who can use it are the companies that have made the biggest mistakes, like the car manufacturers.”

Monitor intern Brendan Conway in New York contributed to this report.

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