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Low- and Moderate-Income Tax Credits Deliver More Bang for the Buck Than High-Income Tax Cuts

In this week’s US News & World Report blog post, I discussed the policies that would most likely boost the flagging recovery at a time when the economy is suffering from excess unemployment and underutilized business capacity:

If policymakers want the best policies to create jobs and cut unemployment as soon as possible, they should focus on policies that boost demand for goods and services — not policies to expand the economy's capacity to supply goods and services.

I applied this logic to a key difference between the one-year tax cut extension bills that the Democrat-controlled Senate passed last week and the Republican-controlled House passed this week.  Both bills extend the so-called “middle-class tax cuts” enacted in 2001 and 2003 and “patch” the Alternative Minimum Tax for 2012 to limit its reach to relatively high-income taxpayers.  The House bill would also extend the upper-income 2001 and 2003 tax cuts, making the dubious argument that doing so would prevent a “job-killing” tax increase on small businesses, while the Senate bill would extend tax credits that President Obama and Congress enacted in 2009 that mainly benefit low-and moderate-income households.

I opined that the $27 billion spent to extend the tax credits in the Senate bill would likely boost economic growth and job creation more than the $49 billion to extend the upper-income tax cuts in the House bill.  I didn’t have space to lay out the underlying analysis there, but here it is:

For $27 billion of tax credits to generate the same increase in gross domestic product (GDP) or employment as $49 billion in upper-income tax cuts, the tax credits would have to have a GDP-bang-for-the-budgetary-buck that is nearly twice as large.  In fact, the evidence suggests a much larger difference.

  • In its most recent quarterly analysis of the estimated impact of the 2009 Recovery Act on employment and economic output, the Congressional Budget Office (CBO) estimates that refundable tax credits added between 40 cents and $2.10 to economic output per dollar of budgetary cost and that a one-year tax cut for higher-income people added between 10 cents and 60 cents.  That’s a potency advantage of 3-to-1 or 4-to-1 for the credits.  Moreover, I think the evidence points to the effect being closer to the top of CBO’s range than to the bottom.
  • Moody’s Analytics chief economist Mark Zandi that the credits add to GDP between $1.20 to $1.40 per dollar spent (CBO’s estimates are measured over a longer cumulative time period) while the effect of the upper-income tax cuts will likely be in the 30-cent to 40-cent range or less (since Zandi’s estimate is for a permanent extension, not a one-year extension).  Once again, the credits are much more than twice as cost effective.

The economy would benefit greatly from a bold plan combining temporary, high bang-for-the-buck policies that provide more support for the economy in the next year or two with a balanced plan for stabilizing deficits and debt in the longer term that begins to take effect in a few years when the economy is stronger.  It’s hard to see how the House bill — which compared with the Senate bill adds more to the deficit, does less for the economy, and makes inequality worse —moves the ball in that direction.