"Obama Eyes $310 Billion in Tax Cuts" the headline blares. The Obama team comes to town to start the new year, and the run-up to his inauguration, with this announcement. How sly.
This Obama tax cut package is to be part of the broader stimulus package now estimated to cost $775 billion. The problem is that there are tax cuts and there are tax cuts, and there are other things Obama calls tax cuts that are not even tax cuts. The "tax cuts" Obama is proposing for his stimulus package, like the rest of his stimulus package, are not going to stimulate anything.
Tax cuts do not stimulate the economy by "putting money in people's pockets" which they can then spend, as even some Republicans, including George Bush, mistakenly say. That's an old-fashioned Keynesian strategy, and, if it worked, the same result could be achieved by sending out increased welfare checks, which also puts money in people's pockets, which they can spend. But it doesn't work, because it doesn't do anything to change the basic incentives governing the economy, and because just borrowing money and then sending it out to people, in "tax rebate" checks or welfare checks, doesn't add anything to the economy on net.
Tax cuts stimulate the economy when they involve reductions in tax rates. The reduction in rates improves incentives for savings, investment, business creation and expansion, job creation, entrepreneurship, and work, by allowing people to keep a greater percentage of the reward produced by these activities. This improves the economy not just by the dollar amount of the tax cut. The improved incentives affect every economic decision and every dollar in the entire economy. The astoundingly successful Reagan tax cuts in the 1980s, as well as the astoundingly successful Kennedy tax cuts of the 1960s, were both based on reducing tax rates, and were successful for these reasons.
But the Obama tax cut package studiously avoids any reductions in tax rates anywhere. The centerpiece of the plan is a $500 per worker tax credit, estimated to cost $150 billion. The government will just borrow $150 billion from the private economy to give away in these tax credits, so there will be no net gain to the economy. Nor will there be any improved incentives to save, or invest, or start or expand a business, or hire new workers. The credit does not even provide increased incentives to work, because once the worker is over a very low income threshold of about $8,000 per year, the amount of the credit does not increase for increased work and income.
Notice that these arguments apply even for workers who do pay considerable income taxes. Suppose you work and earn enough to pay $5,000 per year in income taxes. The Obama tax credit will reduce your income taxes by $500. In this case, the credit is a real tax cut. But it still will not stimulate the economy for the reasons stated above, it does not add to the economy on net and it does not improve incentives. It is a Keynesian tax cut, not a supply-side tax cut, because it is a flat cash rebate, effectively the same as more government spending, not a reduction in rates.
Keynesians think that the way to increase economic growth is to increase deficits and government spending. We tried that in the 1970s, and we got inflation along with ever worsening recessions. We tried it in the 1930s, and we got the Great Depression lasting for over 10 years. It doesn't work.
Indeed, the Wall Street Journal news story on the Obama tax package says regarding this $500 per worker tax credit, "This part of the plan is similar to a bipartisan initiative launched in early 2008, which sent out checks worth $131 billion." Precisely. Bush and the Democrats joined together a year ago to agree on a stimulus package sending out $131 billion in "tax rebates" to workers all across the country. Those tax rebates were very similar to Obama's tax credits today. They involved no reduction in tax rates, or improved incentives anywhere. They were based on a Keynesian rationale, just like Obama's tax credits -- stimulate the economy by increasing government deficits and providing cash rebates for people to spend.
And, of course, that tax rebate stimulus package from a year ago didn't work. The economy continued to worsen throughout the year, and financial markets collapsed in the fall. Henry Paulson was back in September asking for another $700 billion, to save the economy supposedly from complete collapse, and another Depression.
THEN THERE IS THE PART of the Obama tax cut that is not a tax cut. The bottom 40% of income earners do not pay income taxes on net. The $500 per worker Obama income tax credit will consequently not reduce income taxes for these workers. It will involve instead another check going from other taxpayers to these workers, which is actually just increased government spending, indeed, increased welfare.
Indeed, another part of the Obama tax cut plan is even more overt. Obama proposes to include in that plan an increase in the scandal-ridden Earned Income Tax Credit (EITC). The EITC goes to the lowest income workers, who do not pay federal income taxes, and it is universally recognized as a welfare program. In this, as in other provisions of the overall stimulus package, Obama and the Democrats are effectively arguing that they are going to stimulate the economy by increasing welfare. Reagan and the Republicans stimulated the economy by cutting marginal tax rates, providing incentives to save, invest, produce, start and expand businesses, and create jobs (as Kennedy and the Democrats did in the 1960s). Now Obama and the Democrats claim they are going to do the same by increasing welfare and government spending.
Obama tries to argue that his $500 per worker income tax credit is a tax cut even for workers who do not pay income taxes because these workers still pay payroll taxes for Social Security and Medicare. But the only connection between this tax credit and payroll taxes is purely rhetorical. If Obama wants to claim credit for a cut in payroll taxes, then he can propose a cut in payroll taxes. Then Obama can tell us how much sooner the Social Security trust funds will run out and leave the program bankrupt because of his tax credit. The answer in regard to Obama's $500 per worker credit is zero, because that credit does not involve a reduction in payroll taxes of any sort; it is an income tax credit, not a payroll tax cut.
Another component of the Obama $310 billion "tax cut" package is a proposal for a one-year tax credit of $3,000 to businesses for each new job created, costing a pricey $40 billion to $50 billion. Congress already adopted a similar plan proposed by former Sen. Dan Quayle back in the 1980s, called the Targeted Jobs Tax Credit (TJTC). Over the years this has been changed into the Work Opportunity Tax Credit (WOTC), which provides $2,400 for each new adult worker hired, $4,800 for hiring a disabled veteran, and $9,600 for hiring welfare recipients, high risk youths, and qualified ex-felons. It is unclear whether Obama is aware of this history, but his tax credit is not going to produce any more hiring than the already existing WOTC.
Studies of these tax credits over the years have concluded that the credits have mostly gone for workers that would have been hired anyway, with little if any net new jobs created. And this does not include the jobs lost from the private sector when the government borrowed the additional funds to cover the tax credits. Steve Entin of the Institute for Research on the Economics of Taxation argues that such a tax credit is unlikely to stimulate much employment when the economy is down and businesses are not expanding. "Given the current degree of uncertainty about where the economy is headed," he writes, "the credit is not likely to achieve much for many months, until we are already on the upturn, at which time it would not be needed."
Other provisions of the overall stimulus package follow on the theme of stimulating the economy through increased welfare and government spending. The plan includes major expansions of unemployment compensation, including extending unemployment insurance to part-time workers. It also includes increased Medicaid coverage, and subsidies for employers continuing health insurance for laid off workers. Another $140 billion to $200 billion would go for aid to states to be spent on Medicaid and education. The government's borrowing hundreds of billions for such spending is not going to stimulate anything. It may produce a drag on the economy by increasing dependency.
Then there is another couple of hundred billion for increased spending on infrastructure, including building and renovating roads, highways, bridges, and schools, and making government buildings more energy efficient. Such infrastructure spending was the central strategy Japan used to counter its severe economic downturn of the 1990s, which nevertheless continued for over 10 years. In the U.S., these infrastructure projects take years to get up and running, and are often bogged down by lawsuits relating to the environment and other factors, leaving such projects unsuited for short-term stimulus spending. In any event, again, government borrowing of hundreds of billions for such increased spending would not add anything to the economy on net.
THE WALL STREET JOURNAL REPORTS Obama transition spokeswoman Stephanie Cutter as saying, "We're working with Congress to develop a tax cut package based on a simple principle: What will have the biggest and most immediate impact on creating private sector jobs and strengthening the middle class? We're guided by what works, not by any ideology or special interests."
This propaganda spin is exactly the opposite of what Obama is doing. Obama is studiously avoiding exactly what would work, with the biggest and most immediate impact, because he is so ideologically opposed to the pro-growth, free-market policies that would produce that result. Instead, his ideology is leading him to exactly what will not work to promote an economic recovery, increased welfare, government spending, and trillion dollar deficits. Here is what would work.
The Republicans should advance a proposal that would sharply reduce the 25% income tax rate that applies to the middle class to 15%. This would leave 90% of workers with a flat rate tax of 15%, or even less. Such reduced tax rates would provide real incentives to stimulate the economy, as discussed above. A bill providing for this should be introduced as soon as possible, to get the debate going. This proposal serves as an alternative to the rest of the Obama tax plan to be introduced later, as well as the stimulus package. Senate Minority Leader Mitch McConnell raised precisely this proposal last Sunday. Bravo.
Other proposals would promote economic recovery and growth even more. Most urgent, in terms of producing the biggest and most immediate pro-growth impact, is to reduce the outdated and uncompetitive federal corporate tax rate of 35% at least to 25%, if not the 19% recently adopted by Germany and Canada. The Bush tax cuts for capital gains and dividends should be made permanent. Also urgent would be to adopt immediate expensing, meaning deductions, for investment in capital equipment, rather than depreciation, which drags the deductions out over many years. This would have the same effect as a rate reduction for investors, by increasing the percentage of the reward that such investors could keep. A true economic boom would be created if Congress also reduced the top marginal income tax rate to 25%.
But McCain proposed most of these ideas, and Obama ridiculed them, and Obama won. So Republicans should not expect to be able to advance such ideas effectively in Congress right now, especially since they are in such a distinct minority. Conservative commentators can and should promote these ideas as the real effective and practical ways to promote economic growth and get America booming again, and Republicans can run on them in future races. But the one idea that Republicans can effectively advance right now politically is the middle class income tax rate reduction discussed above.
Another urgent, pro-growth reform is deregulation to allow drilling for oil and natural gas, offshore and onshore in ANWR and elsewhere, and renewed expansion of nuclear power production. This would promote economic growth both by reviving a powerful energy industry in America, and by providing low cost, reliable supplies of energy to the rest of the economy. Removing any regulatory barriers to development and production of alternative energy would be very helpful as well. But an alternative energy industry built on massive government subsidies would be a net drag on the economy.
Republicans and conservatives should be careful to note that the inherently powerful American economy retains natural tendencies to recover. They should not preclude that possibility in criticizing the Obama/Democrat stimulus package. Economic growth may well return later this year regardless of what Obama and the Democrats do.
But neither can we allow Obama to pose unchallenged as proposing enormous tax cuts when they are mostly a mirage, or worse, actually increased government spending and welfare, rather than tax cuts. We must start aggressively advancing that argument now, and the case more generally against Keynesian government spending and enormous deficits as the keys to recovery, and aggressively offer instead the real policies that would restore growth and prosperity, and set off a new economic boom.
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