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How Congress' tax-cut decision may affect economy

Associated Press | 11/30/2010, 7:51 p.m.

The budget deficit would fall to $904 billion in 2011, from $1.3 trillion in the just-ended budget year. That would be due to the additional taxes paid by higher-income Americans.

Option Two: Extend the tax cuts for one or two years for the highest earners and permanently for everyone else.

Moody’s Analytics estimates this scenario would help the economy more than the first approach. The economy would grow 2.95 percent next year — a 0.4 percentage point improvement over Option One.

Unemployment would average 9.9 percent next year. That would be slightly worse than the 9.7 percent average rate estimated for this year. Stronger growth wouldn’t be enough to prevent the unemployment rate from rising as more jobseekers, perhaps feeling better about their prospects, resume their search for work.

Even though no one’s taxes would rise in 2011, the budget deficit would drop to $943 billion from $1.3 trillion this year. That’s because tax revenue would rise as people spent more and stimulated more economic activity.

The reasoning is that Option Two would deliver a psychological boost: Americans, regardless of income, would know their income taxes wouldn’t rise anytime soon. High earners would have more money to spend than under Option One.

Obama and Republicans have signaled their openness to extending the tax cuts for everyone temporarily, perhaps for one or two years. That would force Obama to face the issue again in 2012, when he’ll likely seek re-election. Senate Minority Leader Mitch McConnell, R-Ky., says he’ll fight to make sure no one, regardless of income, would face a tax increase once any extended tax cuts expire.

Supporters say the economy is too fragile now to boost taxes even on the highest earners and risk causing them to spend less. At the same time, a temporary extension wouldn’t necessarily swell the budget deficit over the long run.

Option Three: Make the tax cuts permanent for everyone. This is the plan Republicans favor.

By Moody’s calculations, the impact on unemployment, growth and the deficit in 2011 would be the same as in Option Two.

Still, renewing the tax cuts across the board would swell the debt over the next decade by nearly $4 trillion, the Congressional Budget Office says. That’s even after accounting for the extra revenue that would flow to the government as permanently lower taxes boosted spending and growth.

Besides, many economists say high-income Americans tend to squirrel away most of the tax money they save. A report from the Congressional Budget Office agreed.

Mark Zandi, chief economist at Moody’s Analytics, calculated that when higher earners get an extra dollar of after-tax income, they spend just 40 cents of it. Middle-income Americans spend 66 cents. The poor spend almost all of it. Even so, as higher earners chip in and spend, the economy benefits.

Allen Sinai, chief economist at Decision Economics, fears that letting the tax cuts for high-income Americans expire could reduce the flow of money into private equity firms, venture capital and other investments that “grease the wheels of entrepreneurship in the U.S. economy.”

Under Sinai’s estimates, extending the tax cuts for all would provide the biggest boost to spending and growth. People and businesses would know they could count on the money in the future.

Yet even if the tax cuts were extended for everyone, unemployment would still be expected to rise next year. Economic growth still wouldn’t be robust enough to create enough jobs.

Associated Press