Higher rates or fewer tax breaks -- what's worse?

WASHINGTON (AP) — In the fiscal cliff wars, a pivotal battle is raging between Democrats demanding to raise revenue by boosting tax rates on the nation's highest earners and Republicans insisting on eliminating deductions and other tax breaks instead. Which is better for the economy? Analysts say it depends. Economists generally agree that a simpler tax code with lower rates and fewer deductions, exemptions and credits would help the economy. With fewer tax preferences, people would be more likely to seek the best investments for their money instead of the most lucrative tax breaks. And lower rates would leave them more money to spend. Both would add oomph to the economy. But ask whether the higher tax rates that President Barack Obama wants would hurt the economy more than curbing deductions, as Republicans assert, and the picture is less clear. While many economists say the economy theoretically would work more efficiently if the tax code provided fewer preferences, many said it would depend on which deductions lawmakers curb — a complicated exercise in a world where one person's wasteful loophole may be viewed by others as an economic lifeline. For example, one of the biggest tax breaks is the widely popular deduction for interest on home mortgages below $1 million. Because of it, the government this year will take in $87 billion less than it would if the deduction didn't exist. That deduction allows many to buy homes they otherwise couldn't afford and is strenuously defended by the housing industry. But critics say it does little to help lower-income people while it encourages others to go into debt for costlier homes than they need — an activity they say taxpayers should not subsidize. "I'd definitely go for cutting deductions first, especially if I have the opportunity to make the choices about which deductions go," said Alan Auerbach, director of the Robert Burch Center for Tax Policy and Public Finance at the University of California, Berkeley. The clash is a key part of negotiations for a deal to avert big tax increases and spending cuts due to begin in January — the fiscal cliff — unless Obama and Congress reach an accord on some other way to rein in the government's ballooning debt. Obama wants to raise $1.6 trillion in revenue over the next 10 years, partly by letting decade-old tax cuts on the country's highest earners expire at the end of the year. He would continue those Bush-era tax cuts for everyone except individuals earning more than $200,000 and couples making above $250,000. The highest rates on top-paid Americans would rise from 33 percent and 35 percent today to 36 percent and 39.6 percent. House Speaker John Boehner, R-Ohio, has offered $800 billion in new revenues to be raised by reducing or eliminating unspecified tax breaks on upper-income people. There are more than 100 tax breaks with a cumulative price tag estimated at $1.1 trillion yearly. They range from huge breaks like the deduction for charitable contributions and the income exclusion for employer-provided health insurance to obscure tax incentives for capturing carbon dioxide emissions or maintaining railroad tracks. The nonpartisan Congressional Budget Office said in a report last month that raising tax rates would dampen people's incentive to work and reduce the nation's labor supply. Raising the same amount of revenue by eliminating tax breaks would probably be less negative, but the impact would depend on which deductions were erased, the budget office said. A separate study by the same agency and in the same month, however, suggested that the economic harm from letting tax rates rise for top earners would be relatively negligible. That report estimated that extending the George W. Bush-era tax breaks for everyone would mean the economy would grow by 1.4 percent more than if all the tax cuts are allowed to expire. Extending the tax breaks for all but the top earners as Obama wants would produce economic growth of 1.3 percent, just 0.1 percent less. In a nearly $16 trillion economy, that one-tenth of 1 percent equals $16 billion. While higher tax rates can discourage investment, "whether or not we actually see significant changes in behavior from small changes in tax rates is another story," said Joe Rosenberg, research associate at the bipartisan Tax Policy Center, which analyzes tax policy. "We do see some, but the magnitude is probably fairly small." Part of the dispute is grounded in politics. Obama made raising rates on the wealthy a keystone of his re-election campaign. For two decades, Republicans have made opposition to higher tax rates their party's mantra. Neither side is eager to surrender. The present faceoff is also a tactical duel ahead of an even larger war over revamping the entire tax code that could come next year. Both sides know that if tax rates on the wealthy rise now, it will be harder to push them back down later. In addition, the battle underscores ideological differences in the two parties' constituencies. Republicans say raising tax rates on high-income Americans discourages investments that would produce new jobs. "Here's how Republicans think," said Kenneth Kies, a former top House GOP tax aide and now a tax lobbyist. "If I'm a risk-taker and I'm getting ready to invest $1, if I'm successful and the top rate is 35 percent, I get to keep 65 cents." If the top tax rate is much higher, Kies said, he would get to keep less "and my incentive to invest is significantly reduced." For Democrats, imposing higher tax rates on people making the most money is a fair way to make them contribute to deficit reduction. They say Obama would merely return rates to levels that existed under President Bill Clinton, and the economy prospered then. Because various tax breaks have such powerful defenders — for example, charities, churches and colleges — it's politically difficult to limit them. The subsequent search for revenue could expose the middle class to higher taxes, Democrats say. During the presidential campaign, Republican nominee Mitt Romney suggested limiting itemized deductions to a dollar cap, such as $25,000. The nonpartisan Tax Policy Center estimates that capping deductions at $25,000 would raise $1.3 trillion. But 29 percent of it would come from those earning under $200,000, whose taxes both parties say they don't want to increase.

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Instant View: November nonfarm payrolls rose by 146,000

NEW YORK (Reuters) - Nonfarm employment increased by 146,000 jobs last month, the Labor Department said on Friday, defying expectations of a sharp pull back related to superstorm Sandy. However, job gains for both September and October were revised to show 49,000 fewer jobs created in those months than earlier reported. The jobless rate fell to 7.7 percent last month, the lowest since December 2008. But the drop was because people gave up the search for work, which does not bode well for the economy U.S. nonfarm payrolls graphic: http://link.reuters.com/ram54t ANALYSTS COMMENTS: DAN HECKMAN, SENIOR FIXED INCOME STRATEGIST, U.S. BANK WEALTH MANAGEMENT, MINNEAPOLIS "It would be our view point that this report is conflicting with a number of data. We haven't gotten a full impact of hurricane Sandy. We have an improving housing market, but this report shows construction jobs falling by 20,000. This is a milkshake of a lot of data points which don't make sense. "All in all, it's better-than-what we had hoped. The market didn't expect a pickup in retail jobs. But we have to see how many of these jobs will go away after the holiday season. "What are we are going back to focus on the 'fiscal cliff.' We are going also to focus on Europe with the drop in the German industrial output. It might be going into a recession. That's worrisome since that's Europe's largest economy." JOHN KILDUFF, PARTNER AT AGAIN CAPITAL LLC IN NEW YORK "The employment report indicates growing strength in the economy, despite the downward job creation revisions also contained in the report. "Recent data have been mostly positive, as well, and should feed into increased consumer confidence, all of which should provide some stability to crude oil prices. "The energy complex has been flagging, of late, so the demand that translates from increasing employment will be supportive of prices." MICHAEL KASTNER, PARTNER, HALYARD ASSET MANAGEMENT, WHITE PLAINS, NEW YORK "I'm kind of surprised. It's hard to figure out with what's going on with Sandy. The market was looking for something very different. Overall it's good to see. The payroll number is very encouraging. The bond players are not buying it though because the long end would have sold off more." RYAN SWEET, SENIOR ECONOMIST, MOODY'S ANALYTICS, WEST CHESTER, PENNSYLVANIA "Claims are very choppy from the hurricane distortions working through the system. The effect from the storm does seem to be temporary. We are not going to get clean readings on claims for several more weeks. We also have the typical year-end holiday distortions. "Businesses are nervous about the fiscal cliff but they are not in a panic. They are in a holding pattern. They are not hiring or firing. This is actually a reason for optimism. If we make it past the fiscal cliff, hiring might pick up." JACOB OUBINA, SENIOR U.S. ECONOMIST, RBC CAPITAL MARKETS, NEW YORK "The big takeaway is that Sandy did not have the negative effect that people thought it would have. We are left with a number that is around the average of the year and so this not dramatically better than feared. "It is also not a breakout of the trend. The labor market is not getting worse, but is also not getting much better as it is unchanged relative to the recent trend. This should have no impact on Fed policy and the central bank should remain on cruise control and continue with the QE program into the new year." DAVID SLOAN, ECONOMIST, 4CAST LTD, NEW YORK "The surprise was that hurricane Sandy didn't have much of an impact. Otherwise really it is more of the same. The payrolls are pretty much in line with trend and the revisions were significant in government but fairly neutral in the private sector, and the private sector payrolls are maintaining the pre-hurricane trend. The picture remains as it was before hurricane Sandy." JEREMY LAWSON SENIOR US ECONOMIST BNP PARIBAS, NEW YORK "Private payrolls did decline a little bit in the month so maybe this is a sign that Sandy didn't have much of an impact on employment. It doesn't change the outlook for the Fed...I still would be expecting them to announce next week that they'll be extending their purchases to next year. "I wouldn't go far necessarily, the big issue over the next few months is what happens with the fiscal cliff. Our view is that plays out in a benign way." KATHY LIEN, MANAGING DIRECTOR, BK ASSET MANAGEMENT, NEW YORK "Overall, this is a pretty good number, even though we had a downward revision to the previous month. Most important, the unemployment level dropped to its lowest level since December 2008. Sandy didn't have as much of an impact as many feared. "The real question though is whether this changes the Fed's attitude toward more stimulus. It doesn't remove the need for stimulus but might convince the Fed to opt for a smaller program. The dollar is rallying right now, and that should last, particularly against the yen." KATHY JONES, FIXED-INCOME STRATEGIST, CHARLES SCHWAB, NEW YORK The data is even more muddled than we thought because the BLS is telling us that superstorm Sandy did not impact the numbers. The downward revision to the previous month's payroll growth almost offsets the higher than expected number this month. And the decline in the unemployment rate, which is a good sign, may be tied to a decline in the labor force participation rate. You have good news here and bad news so I would not call it a particularly strong report." PETER HOOPER, GLOBAL CHIEF ECONOMIST, DEUTSCHE BANK, NEW YORK "The headline payroll number suggests hurricane Sandy had less effect than might have been feared. The unemployment rate coming down is good news on the surface, but it reflects a decline in labor force participation. The key is that the employment to population ratio has not really come down in this recovery. Some of this reflects discouraged workers and part of it is that baby boomers are starting to reach retirement age. Other measures showing people working part-time when they would like to work full-time are quite elevated. The payroll numbers look okay, about in line with numbers we've had for the last year, but it's still a market that is soft underneath." JOSEPH TREVISANI, CHIEF MARKET STRATEGIST, WORLDWIDE MARKETS, WOODCLIFF LAKE, NEW JERSEY "Despite the projected effects of Hurricane Sandy job production in November was on a par with the prior three months, that is a good sign for December and the first quarter." RUSSELL PRICE, SENIOR ECONOMIST, AMERIPRISE FINANCIAL, TROY, MICHIGAN "Initial claims are settling back into their pre-Sandy levels. So the negative impact from the spike that we experienced after hurricane Sandy is abating. "It's a little bit too early (to forecast December) but it does give us a positive trend that claims have now fallen for four straight weeks and it's a positive indicator that the labor market is remaining fairly solid although certainly not robust by any means." MARKET REACTION: STOCKS: U.S. stock index futures turn positive BONDS: U.S. bond prices down, 30-year bonds fall a point in price FOREX: The dollar gains versus euro

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ECB warns Hungary again over central bank independence

BUDAPEST (Reuters) - ECB President Mario Draghi said on Friday that Hungary's central bank must retain its independence to be credible - a rare public warning about undue political influence ahead of a change in the bank's leadership. Draghi's remarks coincided with the latest in a string of calls by ministers for closer co-ordination between Prime Minister Viktor Orban's government and the National Bank of Hungary to shore up central Europe's most indebted economy. The central bank has been at loggerheads with Orban's government for over two years and perceived threats to its independence have also brought clashes between Hungary, the European Commission and the European Central Bank itself. Orban, who has appointed people close to his Fidesz party to key public posts since taking power in 2010, will pick a new governor in February to replace Andras Simor, whose six-year mandate expires in March. Some analysts are concerned Orban will choose a loyalist, which could make the bank more politicized and usher in unconventional steps to boost growth ahead of 2014 elections. Rate-setters already appointed by the ruling Fidesz party's parliament majority have outvoted Simor and his deputies in the past four months, cutting rates to aid the sickly economy. "A key prerequisite for a credible monetary policy is the independence of the central bank," Draghi told a conference in Budapest organized by the National Bank of Hungary. "The ultimate success of a central bank in maintaining price stability depends on its credibility." Independence means the central bank must have the means and instruments needed to achieve its price stability objective without being influenced by outside forces, Draghi added. He also said lowering interest rates in an indebted economy may risk weakening its currency, which might in turn lead to higher inflation and offset the impact of economic stimulus. "Credible inflation-targeting in small open economies also depends on central banks' recognition of the impact of their monetary policy decisions on the exchange rate," Draghi said. "For example, in the presence of heavily indebted private and public sectors with large open foreign exchange positions, central banks have little space for maneuver when faced with a flagging economy." RATE CUTS Hungary's central bank has cut interest rates by a total 100 basis points in the past four months to 6 percent, and more easing is expected, with a clear majority of Monetary Council members now prioritizing economic growth over inflation risks. Two of the four dovish rate-setters said in a newspaper interview earlier on Friday that the bank could cut rates further, and that the base rate could realistically be lowered to around 5 percent by the end of 2013. One of them, Ferenc Gerhardt, said further rate cuts depended on the forint's exchange rate, the cost of insuring Hungary's debt against default, and bond yields. He did not mention inflation risks, but the four doves have said depressed demand will keep a lid on inflation. Simor and his two deputies, who were appointed under a previous government, have opposed the bank's recent rate cuts, warning about the risks of inflation sticking at higher levels and a potential market backlash later. He told the same conference on Friday that monetary policy can stimulate economic growth only as long as it does not jeopardize price stability. He said letting inflation loose was not the way to produce lasting additional growth in the economy. Hungary's annual inflation was running at 6.0 percent in October, double the bank's 3 percent medium-term target, which it has said could be achieved in 2014. "In my opinion, when inflation expectations, i.e. the longer-term inflation outlook, become uncertain, the central bank should act much more firmly to keep price and wage-setting behavior disciplined," Simor said in a speech. He said fiscal consolidation in Hungary must be made credible and debt must be put on a sustainable declining path. The government has kept the budget deficit below the EU's 3 percent ceiling this year, mostly by taxing banks and foreign energy and telecoms firms, avoiding austerity measures. GREATER "HARMONY" While Orban has refrained from criticizing the central bank in the past few months, he has suggested in the past that it could do more to help the economy. His economy minister has proposed monetary stimulus measures, but it is unclear at this stage what exact steps the bank might take after the new leadership takes control. Minister Mihaly Varga, who is in charge of Hungary's stalled loan talks with the International Monetary Fund, told a newspaper on Friday that changes at the bank next year will enable a "harmonization of fiscal and monetary policy". Varga, seen by some as a potential candidate to replace Simor, and who was present to hear Draghi's speech in Budapest, ruled himself out of the running for the post of governor. "An opportunity will arise for the harmonization of monetary and fiscal policy," Varga was quoted by business daily Napi Gazdasag as saying in an interview. "Naturally, there will not be full harmony, as the two actors, government economic policy and the central bank have partly opposing roles," the minister added.

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Oil price slips as investors await US jobs data

The price of oil eased to near $86 a barrel Friday as investors awaited the release of the monthly U.S. jobs report, a key indicator for the world's largest economy. By early afternoon in Europe, benchmark oil for January delivery was down 24 cents to $86.02 a barrel in electronic trading on the New York Mercantile Exchange. The contract fell $1.62, or 1.8 percent, to finish at $86.26 per barrel in New York. The Labor Department will release November's job figures later in the day. Superstorm Sandy forced stores and restaurants to close along the East Coast and the affected employees will be counted as out of work. But many economists think that if the effects of the storm are put aside, the data will show the U.S. economy is picking up steam. In the wait for the figures, market sentiment was dented after Germany's central bank cut its 2013 economic growth forecast to 0.4 percent from 1.6 percent it had predicted in June. It also lowered its forecast for 2012 to 0.7 percent from 1 percent. "Concerns about demand have currently gained the upper hand," said a report from analysts at Commerzbank in Frankfurt. "We regard the scale of the price slide as exaggerated and expect prices to recover." The conflicts in the Middle East, including unrest in Egypt and the threat of the use of chemical weapons in Syria, which were one of the factors supporting prices recently, seemed to draw less attention Friday. "The eruption of violence in Egypt ... has had no impact on oil prices, though this may change when market players focus their attention more on the risks to supply again," Commerzbank said. Brent crude, which is used to price international varieties of oil, was up 7 cents to $107.10 a barrel in London. In other energy futures trading on the New York Mercantile Exchange: — Heating oil fell 0.19 cent to $2.9413 per gallon. — Wholesale gasoline added 0.98 cent to $2.6067 per gallon. — Natural gas declined 1.6 cents to $3.65 per 1,000 cubic feet.

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TPSA sees Polish telco market tumbling further in 2013

WARSAW (Reuters) - France Telecom's Polish unit TPSA expects its home telecoms market, which it dominates, to shrink by over seven percent next year because of economic woes and further regulatory cuts in mobile charges, its top executive said. TPSA, the former state monopolist, already slashed its 2012 outlook and future dividend payout last month due to economic factors and aggressive competitors, dragging its shares to levels unseen in nine years. In his first interview since the profit warning, Chief Executive Maciej Witucki told Reuters the cuts in intercharge fees among mobile operators - the so-called mobile termination rates (MTRs) - would weigh most on the market in 2013. "The value of the market will fall also next year," Witucki said. "The MTR cut alone will lower the value of the 30-billion zloty ($9.4 billion) market by 2 billion. Second, further price cuts are possible, especially in the voice segment."

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