The new tax cut compromise between the Obama administration and congressional Republicans, which will add $593 billion to the $1 trillion federal deficit, is now also being touted as a back-door stimulus plan. Some economists have estimated that when you add up the deal's different provisions, it will create 3.1 million new jobs. Unfortunately, the model on which those forecasts are based makes some flawed assumptions that lead to an overestimation of the positive effects.

The $954 billion deal can be thought of in two pieces, according to the Center for American Progress. The first is a $133 billion tax cut for the rich -- payback for the donors to Republican campaigns. That portion includes $120 billion in lower taxes for the top 2% of U.S. households, plus $13 billion in estate tax savings. The remaining $821 billion consists of government cash for unemployment benefits, tax cuts for the middle class and small-business job-creation incentives.

The center estimates that over the next two years, the deal will "save or create" 3.1 million jobs, based on the Congressional Budget Office's estimate that each 1% of GDP growth adds a million new jobs, and using calculations from the CBO and economist Mark Zandi about how much of each type of stimulus spending will boost overall GDP.

The 3.1 million jobs estimate from the center breaks down this way, ranked in order by the number of jobs saved or created:
  • Extending the broad-based Bush tax cuts (for the bottom 98%): $360 billion cost, 940,000 new jobs
  • Payroll tax cuts (2 percentage-point reduction): $120 billion cost, 700,000 new jobs
  • Unemployment insurance extension: $56 billion cost, 520,000 new jobs
  • Bonus tax cuts for top 2%: $120 billion cost, 290,000 new jobs
  • 100% expensing/bonus depreciation: $180 billion cost, 260,000 new jobs
  • Refundable low-income tax credits: $38 billion cost, 220,000 new jobs
  • Business extenders such as R&D tax credit: $80 billion cost, 160,000 new jobs
Not Enough Job-Creation Bang For the Deficit-Boosting Buck

What's striking is how much greater the job-creation impact is per dollar spent for some of these programs than for others. For example, extending unemployment insurance creates one job for every $107,692 spent, while it takes nearly four times more -- $413,794 in tax cuts for the wealthiest 2% of Americans -- to create a single job. So much for trickle-down economics.

But the big problem with this economic model is that it grossly exaggerates the number of new jobs created. For example, the same formulas were used when the Obama administration claimed that the $787 billion American Recovery and Reinvestment Act would save or create 3.5 million jobs at a cost of $224,857 per job. The CBO's follow-up report last month estimates that the law saved or created between 1.4 million and 3.6 million jobs. This range is so wide that it doesn't provide much reassurance about the actual results -- but it provides political cover for all sides.

Meanwhile, if the Recovery Act did save or create jobs, why is the unemployment rate back up to 9.8%? The simple answer is that government doesn't create private-sector jobs -- business does. And with profits expected to hit a record $1.66 trillion in 2010 and corporate cash balances at $1.84 trillion, businesses are doing just fine by not creating jobs. Unfortunately, there's nothing in either the older stimulus package or the new tax compromise to change that.

What's really needed to create job growth is transformative innovation -- a development like the Internet in the 1990s that created entirely new industries and contributed 22 million new jobs to the economy. I interviewed 17 CEOs of promising tech startups in October, and I heard repeatedly that tax incentives aren't going to factor into whether they hire or not. What will matter for them is their ability to innovate and compete, something this tax cut compromise won't help with.

Increase your money and finance knowledge from home

Introduction to Preferred Shares

Learn the difference between preferred and common shares.

View Course »

Intro to different retirement accounts

What does it mean to have a 401(k)? IRA?

View Course »