Lawmakers in the United States are currently in talks over a potential deal that could provide $70 billion in tax breaks for businesses and families. If approved, this unexpected fiscal boost could have significant implications for the US economy. The negotiations primarily focus on renewing expired business tax breaks and expanding the child tax credit, with both sectors set to receive equal attention. However, the proposal must make its way through a Congress that is deeply divided on the nation's fiscal path. Some Republican lawmakers are insisting on substantial spending cuts to avoid another government shutdown when temporary funding expires on January 19th and February 2nd.
While the additional cash from the tax breaks would stimulate consumer spending, economists warn that it may also reignite inflation pressures. This could complicate the Federal Reserve's ability to lower interest rates later this year. December data revealed an upswing in inflation towards the end of 2023, driven by rising service costs, although goods prices experienced a decline. The consumer price index registered a 3.4% increase in the year through December, the highest in three months. Notably, prices for clothing and cars continue to rise.
Mickey Levy, a visiting scholar at the Hoover Institution, points out that the tax measures would further accelerate an economy that is already growing faster than its estimated long-term potential. He emphasizes that the lingering effects of pandemic-era fiscal stimulus are still generating robust growth.
The impact of the potential deal will greatly depend on the specific details and structure of the tax breaks. As currently drafted, the agreement would extend the breaks until 2025. However, the talks remain fluid as lawmakers departed for the long weekend, leaving several potential roadblocks in their wake. These stumbling blocks include disagreements over the state and local tax deduction cap, an expansion of the low-income housing tax credit, and a more substantial child tax credit.
According to Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget, the proposed deal may start benefiting households as early as March. However, he cautions that it is unlikely to encourage additional corporate investment. The agreement aims to revive tax breaks for research and development spending, increase the deductibility of investment in equipment, and support business loans. Lawmakers are also considering limiting benefits for foreign research investments, with a focus on incentivizing companies engaged in these activities within the US.
From a political standpoint, the potential tax breaks could be advantageous for President Joe Biden, who has experienced a decline in poll numbers due to voter concerns about the economy. When questioned about the potential inflationary impact of the proposal, Biden's top economic adviser, Lael Brainard, emphasized the bill's benefits. The administration hopes to achieve a balanced package that includes an extension of the child tax credit, particularly targeting low and moderate-income families, as it effectively reduces child poverty.
The specific details of the child tax credit boost under consideration would not match the levels seen during the Covid-19 pandemic. The current proposal falls short of the maximum credit of $3,600 per child and is not fully refundable for those without tax burdens. Additionally, it may not be provided monthly. These details, however, could change as many Democrats vow to block the current deal.
Nancy Vanden Houten, a lead economist at Oxford Economics, believes that the overall size of the tax package would not be sufficient to derail her forecast of the Fed cutting rates in May. She suggests that the impact on the broader economy would be relatively small and unlikely to alter inflation forecasts and the Federal Reserve's decision-making process.
At the very least, the ongoing tax negotiations signal that lawmakers are far from entering an era of austerity, despite warnings from ratings agencies and investors about the unsustainability of the US fiscal trajectory. In November, Moody's Investor Service raised concerns about widening budget deficits and political polarization, even suggesting a possible downgrade of the US sovereign rating. However, the negotiation of tax breaks indicates that Congress is still focused on economic stimulus rather than fiscal restraint.
Negotiators are aiming to have the tax proposal enacted before the start of the annual tax-filing season on January 29th, should an agreement be reached. Regardless of whether it passes, this potential injection of funds could either provide another boost to an already thriving economy or contribute to inflationary pressures. In any case, it is clear that the US economy remains in a state of flux, driven by ongoing fiscal debates and potential policy changes.