Tags: Tax | Cuts | May | Fuel | Economy | Limit | Need

Economists: Tax Cuts May Fuel Economy, Limit Need to Extend Fed Purchases

Wednesday, 08 Dec 2010 12:03 AM

 

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President Barack Obama’s agreement to extend Bush-era income-tax cuts may give U.S. economic growth a boost while reducing pressure on the Federal Reserve to prolong its $600 billion bond-purchase program.

Obama’s deal with congressional Republicans may raise gross domestic product next year by as much as half a percentage point to about 3.1 percent, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. Allen Sinai, chief global economist at Decision Economics in New York, also raised his growth forecast for next year by half a point, to a range of 2.75 percent to 3 percent.

Stocks rallied after the agreement was announced, sending the Standard & Poor’s 500 Index to the highest level since the financial crisis in September 2008 on expectations that the extension of Bush-era tax rates, as well as reduction in payroll taxes, would spur the consumer spending that accounts for 70 percent of the world’s largest economy. Treasuries fell and copper rose to a record.

“It bumps up consumer spending in the first half of next year,” Feroli said. “You’re going to have a pretty nice increase in disposable income.” Much of the increase would come from a 2 percent cut in payroll taxes — which fund Social Security and Medicare — that “we weren’t expecting,” he said.

The payroll-tax cut would apply to all wage earners, an administration official told reporters on a conference call yesterday. That would be an $800 savings for individuals with an income of $40,000. Those who earn salaries of more than $106,800 would save a maximum of $2,136. The proposal would cost the government $120 billion, another official said.

‘Big Deal’

The S&P 500 climbed 0.6 percent to 1,230.33 at 1:21 p.m. in New York. The yield on the 10-year Treasury note rose to 3.12 percent from 2.92 percent late yesterday.

“This is a big deal for the stock market,” Sinai said. The S&P 500 may rise between 15 percent and 20 percent next year, compared with his earlier forecast for a gain of 13 percent to 15 percent, he said.

Obama said yesterday he would accept lower rates on high earners’ income, dividends, capital gains and multimillion-dollar estates for the next two years to break a stalemate over extending the George W. Bush administration’s tax cuts for middle-income taxpayers before Congress adjourns. The current tax rates, enacted in 2001 and 2003, are set to increase Dec. 31.

‘Potential Headwind’

The proposal removes “what would have been a potential headwind” for the economy and takes “some of the pressure off the Fed,” said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts.

The tax agreement means the Fed “may not need to do more” than the $600 billion in asset purchases planned through June to boost the economy, Behravesh said. Fed Chairman Ben S. Bernanke on Dec. 5 said “it’s certainly possible” the Fed may increase purchases beyond that amount.

“Any tax deal and current Fed policy are mutually supportive,” Drew Matus, senior economist at UBS Securities LLC in Stamford, Connecticut, said in an e-mail.

Bernanke, in an interview on CBS Corp.’s “60 Minutes” program, defended the central bank’s efforts to spur the recovery, saying it may take four or five years for the jobless rate to return to a “more normal” level of 5 percent to 6 percent. The rate last month rose to 9.8 percent, the highest level since April.

Some Republican lawmakers, including prospective House Speaker John Boehner of Ohio, have said the Fed’s policy of “quantitative easing” may do little to help unemployment and risks weakening the dollar and fueling asset-price bubbles.

Marginal Rates

The tax deal would leave in place marginal rates created in 2001, ranging from 10 percent to 35 percent. It would also preserve for two years the 15 percent rate on most capital gains and dividends, and would temporarily index the alternative minimum tax for inflation. The plan, if approved by Congress, would extend aid for the long-term unemployed for an additional 13 months.

While Republicans such as Senate Minority Leader Mitch McConnell welcomed the compromise, Democrats said they haven’t committed to the plan, and some party activists mounted campaigns to kill it.

“House Democrats have not signed off on this deal,” Maryland Representative Chris Van Hollen, a member of the House Democratic leadership, said today on Bloomberg Television. “I have some serious reservations.”

© Copyright 2014 Bloomberg News. All rights reserved.

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