Alternative Insight

The Tax Deception
Do reducing taxes help the economy?

Quote Oliver Wendell Holmes: "A good catchword can obscure analysis for fifty years." Without proof, the media has pushed catchy expressions into our lexicon, casually and with absolute conviction. Three of the most prominent are:

Raising taxes during a recession will harm the economy.
Lowering taxes during a recession is a necessity.
Small businesses are the lifeblood of the economy and are hampered by tax increases.

In the world of probability, all types of statements might prove correct at certain times. As one example, supporters of lowering taxes during recessions mention Herbert Hoover's tax increase during incipient years of the Great Depression and Franklin Roosevelt's 1936 tax increase to the top brackets, as examples of destructive tax measures. In both cases, economic downturns followed the tax increases. Sounds logical, that if A occurred before B, then A must be responsible for B. However, simple relationships don't automatically constitute logical arguments. In both cases, the presidents raised taxes to balance the budgets and stop runs on the U.S. dollar. By forcing budget revenues to follow budget expenses, these administrations refused to pump the economy with deficit spending and limited the budgets from reacting to the wants of fragile economies. Besides, in 1932, the economy was already falling rapidly, and in 1936, substantial increases in union wages added to corporate uncertainties. Capital rebellion followed the labor rebellion

No damage done when policy makers treat expressions as extravagant words from agenda pushers; major harm occurs if they are used as a guide to regulate the economy. Many oft-quoted phrases are shibboleths; "a saying by adherents of a party, sect, or belief and usually empty of real meaning." Challenging the lack of inquiry formulating these shibboleths contributes to preventing them being considered as drivers of economic policies.

Obama's deficit spending halted the bleeding. What must the administration do to create jobs and diminish unemployment? Debatable. Add to the debate an analysis that unproven shibboleths, such as maintaining low taxes, confuse the issue and are counterproductive. Preferred guides to renovating an egregious economy are:

Taxes respond directly to the budget and not directly to the economy.
Ever since the demands of the United States Civil War, social and economic circumstances have forced American governments to tax its citizens according to budget needs. Massive industrial growth, population expansion and rapid change in all sectors of society prompted government intervention to keep the national ship on even keel and prevent calamities. Budgets have adapted to sharply changing and disparate conditions, forcing immediate responses to wartime, peacetime and distressed times.

A responsible budget solicits taxes to obtain national benefits that exceed the benefits obtained from leaving an equal amount of tax revenue with the wage earners. The budget expense often promoted wage increases that far exceeded the added tax assessments. One example is the interstate highway system, which escalated the automobile industry to become America's prominent revenue maker and employer.

Opposition to specific taxes and tax rates deserve debate, but general assumptions, which only transfer public spending to private spending, and don't increase total spending, skew the economy. Optimizing tax programs is a challenge, and proceeds from not disturbing a suitable quality of life for wage earners, and allowing sufficient profit margins for capital reinvestment. Taxes respond directly to the budget, and not in accord with the shibboleth that taxes can regulate the economy. If that were true, then the Federal Reserve market operations would be superfluous. Corporations, small business, and the public have operated well in all types of tax situations. .Domestic and government spending enter the economy, start from different allocations, and eventually circulate at similar rates.

In the present U.S. economic situation, well-directed government spending can create more jobs, obtain a lower unemployment and raise the GDP to higher levels than randomly directed spending.
Several investigators have compared the effectiveness of tax cuts and government disbursements. The conclusions are contradictory, and the methodologies are questionable:

"The Romers" (College professors Paula and Christina) conclusion, which is at odds with most traditional Keynesian analysis, was that the tax multiplier was 3 - in other words, that every dollar spent on tax cuts would boost GDP by $3. Valerie Ramey of the University of California, San Diego, finds a government-spending multiplier of about 1.4 - a figure close to what the Obama administration assumed, but much smaller than the tax multiplier identified by the Romers. Similarly, in recent research, Andrew Mountford (University of London) and Harald Uhlig (University of Chicago) conclude that a "deficit-financed tax cut is the best fiscal policy to stimulate the economy." In particular, they report that tax cuts are about four times as potent as increases in government spending."

"…we also examined years of large fiscal expansions, defined as increases in the cyclically adjusted deficit by at least 1.5% of GDP. Over 91 such cases, we found that tax cuts were much more expansionary than spending increases."

"…Mark Zandi, chief economist for Moody's, provided estimates of the one year multiplier effect for several fiscal policy options. The multipliers showed that increased government spending would have more of a multiplier effect than tax cuts. Making the Bush tax cuts permanent, had the second lowest multiplier, 0.23. A payroll tax holiday had the largest multiplier for tax cuts, 1.29. Refundable lump-sum tax rebates, the policy used in the Economic Stimulus Act of 2008, had the second largest multiplier for a tax cut." Zandi also notes that extending food stamps and unemployment insurance benefits, and increasing infrastructure spending are the three most effective way to prime the economy's pump.
Zandi, Mark. "A Second Quick Boost From Government Could Spark Recovery." Edited excerpts from congressional testimony July 24, 2008. "

"… $100 billion of additional government spending will lead to an increase in GDP of approximately $150 billion. This means that $100 billion of additional spending will lead to 1 million additional jobs, while a temporary cut in payroll taxes will generate 860,000 jobs. By contrast, a $100 billion cut in corporate taxes will lead to just 200,000 new jobs."

"A personal income tax cut has a slightly lower initial effect on GDP, inflation and the current account than a corresponding government spending shock. Hence, a 1 per cent of GDP tax cut raises GDP by ½-1 per cent compared with the 1-1¾ GDP effect following a government spending shock of similar magnitude. This is basically because part of a tax cut is saved rather than consumed, hence reducing the initial effect on domestic demand. Otherwise, the adjustment mechanisms are rather similar to those described above and the medium-term outcome is almost the same as in a government spending shock."

Which conclusions are more acceptable? If reorientation of the economy is a prerequisite to economic recovery, and the government is able to operate in an optimum theoretical framework, then, the OECD result seems most credible.

Anything the taxpayer can do with tax cuts to advance the economy, a responsible federal government can do with added tax revenue. Being able to redistribute the tax revenue to the most meaningful projects (increasing infrastructure spending) and spenders (unemployment insurance) is an immediate plus. Tax revenue eventually proceeds to the pockets of wage earners and purchasing power, although rearranged, remains a constant. The minimum economic advance is to spend the taxes randomly on purchases of services and products. The reverse is not true. The taxpayer does not have the tools available to the government to stem a downturn and spur growth.

Can consumers supply the funds for new industries in the energy field? Can consumers implement infrastructure projects and employ workers? Despite knowing the answers to these questions, the tax reduction advocates exaggerate another shibboleth: Tax breaks to small businesses, defined as those with less than 500 employees, are necessary to drive the national economy. Although, the U.S. Small Business Administration (SBA) reports that small businesses account for 52 percent of all U.S. workers, these companies are primarily one-person operations, home based, professional businesses, service organizations, franchises, and contract suppliers. They don't drive the economy; they grow from a growing economy, and can't grow without growth in the major industries.

The pharmaceutical industry needs doctors, distributors, lobbyists, pharmacies and other small businesses to sell their products, but the small business don't drive the products; the products drive the establishment and scope of the small businesses.
Forbes top 20 most profitable small businesses are all dependent on the economy (doctor services, accountant services, suppliers), and none drive the economy. This is another example of overestimating the worth of tax cuts; select a shibboleth - small businesses are the lifeblood of the economy and are hampered by tax increases - without digging deep and using the spurious supposition to prove an argument.

Another often-quoted and spurious shibboleth - The government can't create jobs, only private industry creates jobs. Given the profits in the last year, the latter should have no problems creating jobs - and it has, mostly overseas. According to The Economic Policy Institute, "American companies have created 1.4 million jobs overseas this year, compared with less than 1 million in the U.S." While the U.S. middle class struggles, American corporations finance a growing middle class around the world.

U.S. government agencies have originated, developed, and financed the transportation industry, electronics industry, interstate highway system, medical advances, communications, space industry, and the defense industry. Defense agency's DARPA infrastructure initiated the omnipresent Internet. Add the rescue of companies from bankruptcy and promotion of gigantic job and educational programs.

In this recession of excessive unemployment, caring for the needs of the deprived comes before adding to the wants of funds for those who have sufficient resources.

Lowering taxes mainly assists the already employed, who are not the major priority during a recession.
Who pays taxes - the employed. Who receives tax breaks - those who pay taxes. In effect, lowering taxes redistributes federal assistance from needy persons and businesses to the employed and active. Which is preferable? Redistributing income so the employed have more to spend or redistributing the income so the unemployed have something to spend?

Add another benefit: The added tax revenue supports public works (not make works) programs, which repair infrastructure and elevate productivity. The hiring of unemployed, especially youngsters, reduces psychological and social problems. The pill producing industry might suffer and the employed might have less material goods, but all of America is a more shining hill.

The statements, "Raising taxes during a recession will harm the economy," and
"Lowering taxes during a recession is a necessity,
" are shibboleths and not facts. The federal budget dictates the tax revenue.

Lowering taxes is counterproductive if it increases budget deficits.
Stimulating the economy by tax breaks is a psychological phenomenon. The talk, exaggerations, promises and general optimism of tax breaks fashion a more optimistic public, which stimulates spending, investment and courage to carry more debt. The tax breaks add to a major complaint - budget deficits. Not only will the deficit increase, but interest rates will increase. The interest on the national debt is its most important component - principal is rolled over, but interest, which in 2010 was not much higher than in 2005, must be paid.

How significant is this factor. Sufficiently significant for Moody's to warn "that it could move a step closer to cutting the U.S. AAA rating if President Barack Obama's tax and unemployment benefit package becomes law." Moving up the curve of the deficit curve, while moving down the curve of creditor patience, moves towards steep slopes. Bankruptcy often occurs quickly.

Renovating physical and capital infrastructures are top priority.
Reducing government and trade deficits are equally high priority.

The shibboleths: "Raising taxes during a recession will harm the economy, and "Lowering taxes during a recession is a necessity," don't consider all factors affecting the economy.

All this fuss disguises the major problem, the complexity and discord generated by the tax code. Its revision is also a top priority.

The tax code, especially its provisions for tax expenditures, needs an overhaul before tax rates are decided.
Missing from the debate is a central issue, renovating the tax code. How do we determine fair tax rates with a tax code full of loopholes and unfairness? Warren Buffet said that he was taxed at 17.7 per cent on earnings of $46 million, while his secretary, who earned $60,000, was taxed at 30 per cent. Tax expenditures, which are spending programs implemented through the tax code, provide subsidies to individuals and companies through special tax credits, deductions, exclusions, exemptions, and preferential rates, and are the principal culprit. Not all of them need repeal, but all of them need scrutiny. When a taxpayer receives a deduction for charitable contributions, all taxpayers, without their approval, are participating in the contribution. Their taxes compensate for the loss in tax revenue due to the deduction. According to the Washington Post:
"The new tax credits, which will eventually cost the government more than $50 billion a year, are part of a growing array of federal benefits offered through the tax code. Known as "tax expenditures." In budget jargon, such tax breaks were worth more than $1 trillion to recipients last year."

Next to be resolved is fraud. An Internal Revenue Service analysis of 2001 returns estimates 30 to 40 percent of taxpayers cheat on their returns, defrauding the government of $290 billion a year.

Last is the loss of revenue due to loopholes. A Reuters report, Aug 25, 2008, states, "tax and accounting loopholes that largely benefit rich taxpayers and companies cost the government $20 billion a year."

Re-adjust the tax code, scrub earmarks, cut unnecessary spending, including foreign aid and defense, and the federal budget might balance. Instead, we have the conflicting requests for a vigorous economy with low taxes, balanced budgets, earmarks, tax credits, and forget the loopholes and fraud; they aren't worth the effort to investigate.

Will the tax cuts benefit the economy more than government spending?
Is it that easy - rescue a difficult economy by lowering tax rates? Another patch by the economic doctor, who has many patches available. Corporate profits will increase, but will the production engine recharge, will unemployment decrease, and will the nation fulfill its obligations to those most suffering from the downfall?

The latter is too lightly regarded. The social and mental woes affect community engagement and health, lead to additional economic disparities, and eventually must be paid for in other ways.
The Guardian Observer, 21 June 2009, reports "The links between economic woes and depression are well documented. Victoria Walsh, campaigns and policy manager at mental health charity Rethink, said its information centres and telephone advice lines were reporting a surge in people experiencing problems as a result of financial difficulties. 'We are seeing people coming in who have been high fliers and now find life without their jobs overwhelming,' she said."

In the
United States, "Increasing sales in antidepressants and new class of cancer drugs helped US pharma market bounce back in the year 2009 with over 5% growth from less than 2 per cent growth rate a year ago due to economic slow down."

Media salutations, public relations, and political expediency have brightened the private sector and darkened the public sector, conditioning the citizenry to feel comfortable with private initiatives and to question public thrusts. To appease a confuse electorate, political compromise has replaced public responsibility - a route to disaster.

january, 2011