Never in his term as President or before has Barack Obama proposed or negotiated a public policy so beneficial to America's workers as the "deal" he hammered out at the White House with the Republican leadership. And perhaps never in all of American history has a President acted with such hostility and disregard toward all the members of his own party in both houses of Congress. As a result those who should be most pleased, the more "liberal" members of the House of Representatives and the avowed Socialist senator, Bernie Sanders, are instead the most vociferous and bitter in their opposition.
Quite simply, the deal the President negotiated with the Republicans would make the United States the only large and wealthy country in the world to withstand the global wave of reactionary and horribly-timed cuts in government spending. It extends unemployment insurance without further interruptions through next year; it maintains everyone's tax bracket at the level of the Bush tax-cuts; it provides a year of powerful additional stimulus in the form of a two percent tax rebate on earned incomes up to about $107,000; and it reinstates the estate tax at 35 percent. Except for the estate tax, all of these items will stimulate the economy by increasing spending or accelerating the restoration of savings that must precede more spending for many households. The likely effect would be to add about one percent to next year's growth of national income and output, which would mean the creation of about one million additional jobs. This is not all that needs to be done; but it is far better than what was likely as the right wing of the Republican Party and the newly elected Tea Party legislators began to exercise their power.
To win these significant departures from Republican nihilism, what did the President give up? Only three things, which collectively seem like a small price to pay for what he gained. First, the 35 percent rate for estate taxes is a significant cut from the previous rate of 55 percent. If the major purpose of an estate tax is to level the field on which each generation seeks success, then even 55 percent is too low in a world where over four hundred Americans have estates measured in the billions of dollars. However this compromise also eliminates for at least the next two years the otherwise very real possibility that the new Congress could eliminate the estate tax altogether. Second, the inclusion of those making over $250,000 a year in the extension of the Bush tax cuts is unlikely to make a meaningful contribution to economic recovery and is fundamentally unjust. But it is also less than a fifth of the total cost of the package. Third, the package also includes a temporary ability for any business to deduct all of a new investment from taxable profits in the first year. It is well known that this kind of incentive has almost no impact on the actual level of investment, which is dominated by more pressing considerations such as the weak growth of demand and the large amount of idle capacity. Nevertheless the total cost is small and it is not really a cost so much as a shift of tax payments from the present to the future.
In sum, the President struck a deal that allows the U.S. to have the only expansive fiscal policy of any major rich country. In itself this undermines the Republicans' stated objective to defeat Obama in 2012. It has to be good for all of the surviving Democrats (and Independents and Socialists) in both branches of Congress. Their real gripe is that Obama shut them out of the negotiations, contrary to both political party tradition and constitutional definitions of the powers of Congress and the President. No good explanation of why Obama made this decision is readily available; but it appears more than a little related to the growth of the imperial presidency, which has continued apace in the current White House, and to Obama's high regard for conservative, pro-private-market solutions that also appeal to the wealthy. Maybe the President felt that he could not get to an agreement with the hot-tempered rhetoric that each side would increasingly employ if confronted by the other. Still it would have been better if he had maintained communication with his own party and taken time to explain the agreement to them persuasively and thoroughly. Even so, it also would have been a better choice for Pelosi, Frank, Sanders et al. to have supported the package and also introduced resolutions condemning the process.
Be that as it may, it seems overwhelmingly likely that the package negotiated by the President with the Republicans will become law in the next few days. While this will be good news for the economy, at least over the next year, it is still not good enough to dramatically reduce unemployment. As a result there is still a non-trivial chance that the American economy, indeed most of the developed world's economies, may slip into a long period of stagnation.
The seemingly ineffective, endless and increasingly expensive War on Terror continues to expand in many locations around the world. And the now sacrosanct military budget expands with it, at a time when all levels of government in the United States are pressed to meet basic human needs and to make appropriate investments for the future.
The day that investors at home and abroad decide that the United States is an unreliable borrower may be drawing nearer, but it is still some years in the future. A cascade of defaults by municipal governments is a more immediate prospect. The new tax package contains no continuing aid for the states. As a result the states, which face severe budget shortfalls of their own, are not in a strong position to help municipalities that are struggling to pay or refinance their debts while maintaining essential services. Indeed if defaults occur widely among cities and counties, this could lead to defaults by some of the states as well. The federal government is likely to be unwilling or politically unable to act until state and local government defaults have become widespread and inflicted serious damage.
Across the ocean, there is a continuing slow-motion disintegration of the European Monetary Union and perhaps the European Union itself. The "political will" to complete the EU by centralizing the regulation of its troubled banks and of its various members' tax and spending policies is entirely lacking. As a result, sovereign debt deterioration, increasing bank solvency crises, and a collapsing Euro exchange rate seem the most likely outcomes. Already depositors are withdrawing funds from banks in the peripheral European countries out of fear that their deposits will be converted into new, devalued currencies. Coupled with the contractionary fiscal policies being applied to the already contracting economies of the peripheral countries and the high level of problem loans and securities that the banks own, a more general "run" on European banks and a freezing of the bank inter-lending market is a real possibility.
The European peripheral governments and others have been bailing out the banks with government funds. The sovereign debt crisis is thus really a crisis about who will pay the tab for rescuing the banks. At the moment citizens of the weakest countries are effectively paying most of the cost. The chaos and violence that already exists in those countries will be redoubled if it leads to an exit from the Euro. In the meantime weakness in the Euro and weakness in European demand will mean reduced exports from the rest of the world spreading the consequences beyond Europe.
So, after the Obama-Republican stimulus package is passed, there will still be a good chance that the U.S and the rest of the rich world will continue to experience very weak economic conditions, similar to the aftermaths of previous financial crises.
Follow Robert Zevin on Twitter: www.twitter.com/ZevinAssetMgmt