Why the Tax Deal Could Be Obama's Salvation

Democrats should quit complaining about a deal that could restore them to power.

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The "tax compromise" reached by President Obama and Congressional Republicans has left liberal Democrats feeling gypped. But it could end up being a stealth consolation prize for the Democrats after the drubbing they took in the 2010 midterms—and might even pave the way for Obama's reelection in 2012.

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Many Democrats are outraged that Obama agreed to an extension of the Bush-era tax cuts for America's wealthiest earners, which is a top Republican priority. And opposition to the top-tier tax cut could still scuttle the deal in Congress, where lawmakers have to turn the broad framework into a set of laws able to get enough votes to pass the House and Senate. But by blinking on the tax cut, Obama got a long list of concessions from Republicans on other White House priorities, securing an economic "stimulus" program far bigger than most analysts thought possible in Washington's vitriolic climate.

The irony is startling. The $800 billion stimulus program Obama championed in 2009 turned into a political albatross for Democrats, with many voters feeling (mistakenly) that it drained the Treasury while doing nothing for the economy. That was one cause of the Democratic downfall in the midterms. Yet Obama has now negotiated an even bigger stimulus package. The price tag for the tax deal is about $900 billion over two years, which means money that would have been collected by the government will instead go into consumers' pockets, to spend as they see fit. It's borrowed money, of course, so it adds to the huge pile of debt that we'll all have to pay down sooner or later. But many economists, including Federal Reserve Chairman Ben Bernanke, have argued that the weak economy needs exactly this type of boost, since it would put the economy on stronger footing for the inevitable day of reckoning over the debt.

With Stimulus II now on the table, 2011 is already looking better. In a note to clients, Bank of America Merrill Lynch highlighted several positives. The plan could boost GDP growth from 2.3 percent or so in 2011 to as high as 2.9 percent, the bank predicted. It could also boost stock prices and reduce the odds of more "quantitative easing" by the Federal Reserve, which has made investors nervous about runaway inflation down the road and even spooked some insiders at the Fed. After three years of economic gloom, hopeful notes from Wall Street advisers about "upside risks"—rather than downside ones—could itself improve confidence in the stock markets and the economy.

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Obama's compromise would also secure more than a year's worth of aid for the long-term unemployed, giving some predictability to a group of down-on-their-luck Americans who have felt captive to political sideshows in Washington. One unhappy legacy of the Great Recession is an epidemic of long-term unemployment, with about 6.3 million Americans out of work for 27 weeks or longer, and another 1.3 million so discouraged that they've stopped looking for work altogether. Congress has stepped in to augment their unemployment benefits at least seven times since 2008, providing more than $100 billion in aid that has almost entirely been spent, boosting the economy. But those extensions usually last for only a few months before Congress needs to renew them, and concerns over the cost have made passage harder and harder. The new tax deal would lock in the extended aid for 13 months, providing a predictable lifeline for some of the nation's neediest consumers.

The deal would also alleviate the "uncertainty" that business leaders have complained about, which is hard to quantify but counts as an important psychological factor affecting the economy. The fate of the Bush tax cuts has been a concern for every American who pays attention to their finances, since a basic requirement of financial planning is a clear idea of your tax liability in any given year. So consumers now have more clarity about their finances in 2011 and 2012. The tax deal wouldn't affect corporate tax rates, but it would have an optimal short-term impact on practically every business leader, since their tax rates will remain steady instead of going up. And a better feeling about the economy at home translates into a better feeling in the boardroom.

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A variety of other tax cuts included in the plan, such as a temporary reduction in payroll taxes paid by workers, tax credits for low-income families, and accelerated tax writeoffs for business investments, would plow a pile of stimulative measures into one huge bill. For investors hoping Washington will help the economy, that's a lot better than a bunch of smaller bills that would each have to make it through Washington's legislative sawmill. Given concerns about political gridlock, a huge stimulus program prior to the Republican takeover of the House in January would greatly reduce the economic to-do list of a divided Congress.

If the deal passes—and there are no ugly economic surprises—the economy will almost certainly grow more than previously expected over the next two years. And the prime political beneficiary would be Obama, as he campaigns for a second term. Moody's Analytics predicts that the boost to economic growth from $900 billion worth of stimulus would create an additional 1.6 million jobs in 2011, enough to bring the unemployment rate down from about 10 percent at the end of next year—where it would be without any additional stimulus—to about 8.5 percent. "In all likelihood, the recovery would have made it through next year without backtracking into recession," writes Moody's economist Mark Zandi. "But this deal improves those odds significantly." And the trend would continue right through 2012, since it's a two-year plan.

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Until now, the biggest question about the 2012 elections has been whether the economy will be improving enough by then to make voters feel optimistic—which would obviously benefit Obama and other incumbents—or whether an impotent recovery will perpetuate a sense of gloom and decline. Steady job creation and a marked improvement in the unemployment rate by 2012 would enhance job security for those working, and probably boost incomes, since pay rises as demand for workers goes up. And it would obviously help some people at the margins, since the ranks of the unemployed would decline. That may be all the wind an incumbent president needs. Score one for Obama.

If he wins in 2012, of course, the post-election drama could be even more tense than it is now. If a two-year extension of the Bush tax cuts passes this year, it will expire at the end of 2012, which means politicians then will be howling about "tax increases" just as they are now. And by 2012, there may be no choice but to swallow hard and absorb them. The other huge issue in 2012 will be the national debt, which is also topical now, of course, but is unlikely to be seriously addressed before the next presidential election. So if Obama does ride tax cuts to victory in 2012, he may end up riding tax hikes and deep spending cuts to the end of his second term, in 2016. Still, Democrats could do a lot worse.

Twitter: @rickjnewman