A last minute deal may have ended the standoff between Democrats and Republicans, but it is still hard to know whether to laugh or cry over this latest adventure in political theater.
The policy stalemate that preoccupied Washington in recent days was over whether to extend last year’s reduction in the payroll tax from 6.2% to 4.2%. The House voted to extend it for one year and the Senate for two months, but neither chamber wanted to accept the other’s bill.
The House GOP dropped its opposition to the Senate bill Thursday evening. But even if the House approves the short‐term payroll tax cut extension Friday, Congress will likely have to revisit the issue before two months are out.
Despite the tragicomic aspects of the situation, we can identify the economic pros and cons of an extension, and we can use that to understand why the politics are so difficult.
Economists agree that tax cuts tend to stimulate the economy. This occurs in part because additional after‐tax income spurs greater consumer spending, and in part because lower after‐tax wage costs spur employer hiring. Neither impact is likely to be large in the current context because the cut is explicitly temporary.
Consumers will likely save much of any extra income, and firms will not hire many new workers if the after‐tax cost is only lower for a short while.
Nevertheless, it is hard to see why either party would oppose the cut on strictly economic grounds: Republicans claim to endorse tax cuts broadly because they improve incentives, and Democrats claim to believe in (some) tax cuts because they provide economic stimulus.
The problem is that a tax cut now means either increased taxes or lower spending later, assuming the government is going to balance its budget over the long haul. Congress has given no indication it is taking our current debt situation seriously, but most proposed policy changes at least pay lip service to budget balance. And that is where the true conflict arises.
Democrats would love to pay for a cut in the payroll tax with a hike in taxes on high income households. Republicans are adamantly opposed, however, so that approach has no chance politically regardless of its economic merits.
Republicans would gladly pay for the tax cut with reduced spending on any number of programs, such as extended unemployment benefits. Alternatively, they would accept the tax cut, even if not paid for, in exchange for Democratic acceptance of the Keystone XL oil pipeline from Canada to the Gulf of Mexico. Democrats have little interest in these proposals, however, so the Republican approach is problematic, as well. (The Senate bill did agree to accelerate decision‐making on Keystone, but that is hardly approval.)
This shows that the current debate is not really over the payroll tax; it is over the size and scope of government. That is an important topic, but it is not one that will get resolved now. Both sides have too much to lose if they make concessions on policy issues that can be used against them in the upcoming elections.
Instead, Congress will almost certainly approve the deal for a two‐month extension announced Thursday evening. This is basically the Senate bill, tweaked just enough for House Republicans to save face. The big loser will be the U.S. economy, which must endure the uncertainty of renewed squabbling on a longer extension.
It is tempting to blame this outcome on the “extreme” or misguided views of one party or the other (take your pick, depending on your own views). But that is too simple.
The key problem is that, in one crucial respect, all politicians are alike: They want to get re‐elected. In attempting to do so, however, they face different constraints depending on the district they represent. Republicans, especially the more conservative ones, are from states or districts with conservative voters. Democrats the reverse.
Thus even if behind closed doors every member of Congress held the same views on good versus bad policies, gridlock is still likely. Given the current distribution of voter preferences in the United States, roughly half the elected politicians are going to support conservative positions and half the opposite on most issues. Democracy may be the least bad form of government, but it is far from perfect.
This stand‐off will only change if voters convince politicians that, on average, their views have evolved in the direction of either bigger or smaller government. This is what the November 2012 elections may reveal. Until then, politics rather than economic common sense will dominate the policy debate.