A flawed stimulus package

Compared to the priorities expressed by Republicans and Democrats before the negotiations over an economic-stimulus plan began in earnest, the package that emerged last week included major concessions by both sides. Equally noteworthy is the fact that before President Bush had itemized his stimulus priorities, he had already pre-emptively excluded from the negotiations any consideration of permanently extending his 2001 and 2003 tax cuts and reducing the top corporate income-tax rate. Both items are the two most important tax priorities embraced by most of the Republican presidential candidates, conservative Republicans in Congress and the supply-side community.

The stimulus package that emerged from negotiations involving the White House and Republican and Democratic House leaders will total about $150 billion, or roughly 1 percent of this year’s gross domestic product (GDP). About $103 billion will represent tax relief for individuals and families, including an estimated $28 billion that will be rebated to taxpayers who pay Social Security/Medicare payroll taxes but not income taxes. An additional $43 billion will be mostly ill-advised tax relief for businesses based on their capital expenditures.

The stimulus plan will reduce taxes from 10 percent to zero for the first $6,000 in taxable income earned by individuals and the first $12,000 earned by married couples. The maximum relief will be $600 for qualifying individuals. Qualifying married couples will not only receive a maximum tax rebate of $1,200 from this measure; they will also receive a tax rebate (or “children’s bonus”) of $300 per child.

The tax rebates will begin to phase out at the rate of $50 per $1,000 of adjusted gross income (AGI) above $75,000 for individuals and $150,000 for couples. To determine taxable income, filers deduct personal exemptions ($3,500 per person) and either the standard deduction ($10,900 for married couples and $5,450 for individuals) or itemized deductions (mortgage interest, state and local taxes, charitable contributions, etc.). Individuals earning more than $87,000 in AGI will receive no rebate and couples (without children) earning more than $174,000 in AGI will receive no rebate.

A couple with three children and taxable income between $12,000 and about $125,000 (assuming the standard deduction) will receive a total tax rebate of $2,100. A couple with two children working full-time earning $6 an hour will receive a total tax rebate of $1,200 even though they had only $60 in taxable income. (And that is before consideration of the refundable earned-income tax credit of $3,119 and nearly $2,000 in refundable child tax credits.) A couple with two children earning $184,000 in AGI will receive a total tax rebate of $100, while a couple earning $210,000 in AGI with six children will receive no tax relief at all. Major concessions by Republicans included: (1) giving tax rebates to workers who do not pay income taxes; and (2) phasing out the rebates for taxpayers who pay lots of income taxes (e.g., the couple with $184,000 in AGI and a $100 rebate will pay as much as $31,000 in income taxes).

House Speaker Nancy Pelosi, who is committed to bypassing Rep. Charlie Rangel and his Ways and Means Committee and bringing the stimulus package directly to the House floor, also made concessions. She dropped several important priorities, including extending unemployment benefits, temporarily increasing food-stamp allotments and providing assistance to states by increasing the federal share of Medicaid payments. If Senate Democrats try to add these items to the package, they will probably invite a veto.

Allowing businesses to deduct an additional 50 percent for capital expenditures beginning with the first dollar of investment outlays is a bad idea. Businesses always invest in plant, equipment and software during recessions. For example, in 2001, which included an eight-month recession, gross business investment totaled nearly $1.2 trillion. Why give businesses a massive tax cut for investments they would make without the cut? To get the most “bang for the buck,” the Senate should permit the additional depreciation allowance only on investment expenditures above, say, 70 percent of those undertaken in 2007. That would encourage businesses to bring forward into 2008 investment projects that are planned for 2009 (which is the whole idea) without giving them an unnecessary tax break on investment they will undertake regardless of how the economy performs this year.