(Jan 15): The US economy is set for an unexpected fiscal boost if lawmakers back a potential deal for US$70 billion (RM325.5 billion) worth of tax breaks for businesses and families.

Congressional negotiators are locked in talks over renewing expired business tax breaks and boosting the child tax credit, evenly split between both. The proposal will need to pass through a Congress that is deeply divided over the nation’s fiscal trajectory, as some Republican lawmakers push for deep spending cuts as a condition for averting another government shutdown on Jan 19 and Feb 2, when temporary funding expires.

If passed, the tax breaks offer a double-edged sword for an economy that appears on course for a soft landing.

While the extra cash would boost consumer spending, it would also risk reigniting inflation pressures — complicating prospects for the Federal Reserve (Fed) to lower interest rates this year, economists warned. Data for December show that inflation picked up at the end of 2023, fueled by services costs while a decline in goods prices petered out. The consumer price index increased 3.4% in the year through December, the most in three months. Prices for clothing and cars continue to increase.

Mickey Levy, a visiting scholar at the Hoover Institution, said the tax measures would add fuel to an economy that is already growing faster than estimates for its long run potential. The legacy of pandemic-era fiscal stimulus continues to juice growth, he said. 

“There’s already substantial fiscal stimulus driving up economic activity,” he said.

Analysts say much will depend on the final details of any agreement and how the tax breaks will be structured. The draft deal would extend breaks through 2025.

The talks were still in flux as lawmakers left for the long weekend Friday. After halting progress earlier in the week, several potential roadblocks to a bipartisan agreement emerged, including differences over the state-and-local tax deduction cap, an expansion to the low-income housing tax credit and a more robust child tax credit.

If a deal does come together, money could start flowing to households as soon as March, said Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget, which advocates for reducing deficits and debt. He cautions the proposal will do little to encourage additional corporate investment.

The proposed deal would revive tax breaks for research and development spending, boost the deductibility of investment, such as in equipment, and business loans. Lawmakers are discussing restricting benefits for foreign research investments in order to target the benefits to companies conducting such activities in the US.

“This is going to be a decent amount of fiscal cost with very little of it going to encourage new investment in a time when there are still inflation pressures,” Goldwein said.

Still, the plan could be a boon for President Joe Biden, whose poll numbers have slumped amid voter anxiety over the economy. Asked how the White House is weighing the potential inflationary impact of any proposal, Biden’s top economic adviser instead emphasised benefits of the bill.

“We are very much hoping that we can see a balanced package,” National Economic Council Director Lael Brainard said Thursday. “But what is critical for the president is that the child tax credit be extended and particularly be made available for low and moderate income families, because it is so powerful in reducing child poverty.”

The child tax credit boost on the table as of last week wouldn’t be nearly as much as the Covid-era version, which took the maximum credit from US$2,000 to US$3,600 per child. It’s also not fully refundable for those without tax burdens, nor would it be paid monthly. Those details could change, as many Democrats vow to block the current deal.

Nancy Vanden Houten, a lead economist at Oxford Economics, said the overall size of the tax package wouldn’t be enough to derail her view that the Fed will cut rates in May.

“The impact on the broader economy would be relatively small, and probably not enough to change our forecast for inflation and the Fed,” Houten said.

At the very least, the tax negotiations underscore that lawmakers remain a long way from entering an era of austerity even amid warnings from ratings firms and investors that the US fiscal trajectory is unsustainable.

Moody’s Investors Service in November warned it could downgrade the sovereign US rating because of wider budget deficits and political polarisation. It lowered the outlook to negative from stable while affirming the grade at Aaa. Fitch Ratings downgraded the US in August. 

If the tax proposal is agreed, negotiators are aiming for Congress to enact it before the Jan 29 start of the annual tax-filing season. 

“If it passes, it just becomes another shot in the arm for an economy that maybe does, or maybe doesn’t, need it,” said Owen Tedford, a senior research analyst at Beacon Policy Advisors LLC.