BOTTOM LINE: The President’s proposal is larger than expected, with spending proposals and tax cuts both somewhat greater than expected. This proposal does not imply a significant shift in the fiscal restraint in 2012, but it is consistent with our expectation that the payroll tax cut will be extended, and the fact that some of the new proposals involve additional tax cuts increases the probability that Congress will enact them.
1. The total cost of the plan has risen from the previously reported $300bn (2% of GDP) to $447bn (3% of GDP). At first glance it appears that, if enacted, around 75% (or roughly $335bn) of the fiscal effects of the proposal would show up in calendar 2012. We estimate that fiscal restraint under current law would total $270bn, or $160bn net of the extension of the payroll tax cut (to 4.2%) we already assume in our forecast. Thus, if enacted in its entirety, this proposal could shift the fiscal impulse in 2012 from -1.1% of GDP to +0.4% of GDP. However, it is not yet clear how congressional Republicans will respond to the proposal, and we are not changing any of our estimates at this time.
2. The President proposes $253bn in tax cuts, mostly through reduced payroll taxes. This includes four components: (1) A greater payroll tax reduction for employees for 2012 than is effective for 2011, the current rate is 4.2% of employees’ wages up to $106,800 per year; this rate reverts to the standard 6.2% for 2012 if Congress takes no action. The President proposes to cut the employee-side payroll tax to 3.1% for 2012, at a cost of $175bn per year (rather than the $110bn cost of extending the existing cut to 4.2%). (2) A new payroll tax cut for small businesses, which would cut the employer-side payroll tax cut for small businesses on the first $5 million of payroll to 3.1% (from 6.2% currently) and eliminate the employer-side tax for new hires, at a cost of $65bn. This should primarily benefit firms with less than 500 employees, which account for roughly 45% of total payrolls. (3) A $4,000 per employee tax credit for employers that hire workers who have been unemployed for greater than 6 months, at a cost of $8bn. (4) As expected, the President proposed to extend the current 100% expensing for corporate investment through 2012. .
3. A number of spending items are also included in the President’s proposal, but these seem less likely to be approved by Congress. As expected, the President also proposed extension of emergency unemployment compensation (EUC), which expires at year end, at a cost of $49bn. He also proposes fiscal aid to state and local governments ($35bn) and infrastructure ($95bn) and housing ($15bn). While there is a chance that Congress could extend EUC, we believe the likelihood is below 50% and we do not assume extension in our forecast. The other spending proposals appear likely to meet opposition in Congress and seem less likely to be enacted into law.
4. Labor-market focused reforms. The proposal includes a number of programs to discourage long term unemployment, including wage insurance, “bridge to work” programs, and work sharing arrangements. Many of these would be implemented in conjunction with states. We expect Congress to support many of these, in part because their cost appears to be low.
5. The mortgage refinancing proposal was mentioned, but not in detail. The President indicated his economic team will continue to work with the GSEs and their regulator, FHFA, on ways to increase the number of borrower who can refinance at low mortgage rates. We previously estimated that if all borrowers with 30-year fixed rate loans were able to refinance, borrowers’ interest expense would be reduced by $20bn. Given the apparent technical challenges and borrower eligibility issues, the actual savings would presumably be lower. Despite its inclusion in tonight's address, it isn't yet clear whether a refinancing program will come to fruition.
6. No final decisions are likely until November. If they are to be enacted, these proposals would most likely become law as part of the legislation produced by the Joint Committee on Deficit Reduction that was created in the recently enacted Budget Control Act to increase the statutory debt limit, because the President has pledged to offset the cost of his proposal, and this is only likely to occur as part of that process. As expected, the President indicated that he plans to submit a detailed proposal to Congress next week specifying deficit reduction plans. The committee faces a November 23 deadline to agree on finalized legislation, and Congress faces a December 23 deadline to pass it.
From Jan Hatzius