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Will The Tax Bill Stimulus Create Economic Growth?
This article originally appeared in The Daily Capitalist.
There are two ways of looking at the impact of the new tax bill (The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010). One is that giving workers more money via the payroll tax holiday will increase spending in the economy and thus create more economic activity and revive the economy. This is the Keynesian view. Another way of looking at it is that it will have little or no short-term impact on economic growth but it will increase unemployment. This would be the Austrian view.
First let's look at the actual amount of "stimulus" that will be available. I created the chart below from the CBO estimate of the impact of the Bill on the Federal budget. Their assumption is that what isn't taken by the government is left in our pockets to spend. They claim there will be $780.4 billion of new stimulus. But the reality is that is not quite accurate.
The government programs into its budget the revenue that would have received as the result of the expiration of the Bush tax "cuts" as its "normal baseline for those budget years (2011- 2013). The way they see it is that if the taxes don't go up as they had projected, it as a tax "cut" because it reduces projected revenue from their baseline. In the real world the expiration of the Bush tax cuts would have been a tax increase for us.
I made adjustments in the CBO's estimates to estimate the true amount of new relief taxpayers will receive from the Bill. For example, in the "Adjust for Non-stimulative Items" section in the chart below, I note that the extension of the Bush tax cuts (note 1) isn't tax relief at all: we will have the same taxes in 2011 as we had in 2010, so we are not getting any new tax relief and there is no new money in our pockets from it. We just avoided a tax increase. Thus we can't call that stimulus because we have the same as we had before.
This is the same for AMT relief (note 2). There is no new gain to the taxpayer.
The estate tax provision (note 3) is a bit misleading since there wasn't any estate tax in 2010. But the CBO estimated the new revenue that they would have received had the estate tax reverted to the pre-Bush rates. But the tax bill establishes a new estate tax rate that is lower than the CBO had projected, so the CBO sees it as a tax cut. But the reality is that we are going from zero tax in 2010 to $62 billion in new taxes by the 2013 fiscal year. Instead of being "stimulus" it's a tax increase.
The investment incentives (note 4) are more complicated since there were already write-offs for equipment purchases. The tax bill reduced the write-offs on some existing programs and added some new ones. The CBO detail on this was not revealing so I just estimated that the net new benefits versus new tax increases would be about two-thirds of what the CBO had estimated in their baseline budget.
I gave the remaining items full credit as new tax relief.
Here is the result. The first part of the chart, below, shows the CBO's estimates. The section "Adjust for Non-stimulative Items" are my adjustments to show the actual new benefits that would put cash in our pockets.
When you net it all out, the total new tax relief for taxpayers is $229.7 billion. Compare that to a $13.3 trillion economy. That doesn't sound like enough under Keynesian theory to stimulate spending in such a large economy. At least that's what Paul Krugman says. The 2009 Recovery Act allocated $787 billion for stimulus: they've spent $339.5 billion on projects plus $243.4 billion of tax cuts, for a total of $582.8 billion, and that hasn't worked yet, so that would lead one to doubt the efficacy of another $229.7 billion of new tax stimulus.
Keynesians believe consumer spending is the key to recovery. But the Keynesian approach has never worked to revive an economy. Economic growth is created only by saving and production and that generates income and wages which stimulates consumer spending. If the government takes money from taxpayers and spends it, that doesn't create growth. It just wastes capital on projects the government favors. If the Fed prints money to fund government spending, there is only a temporary benefit to whomever gets the new money first; those at the end of the money fix see only higher prices and no benefit.
The supply-siders, such as Art Laffer, believe that lower taxation will lead to economic growth. It makes sense that the less the government sucks out of the economy, more money is available for economic growth. The idea behind the Laffer Curve is that at a certain (high) tax rate, government revenues decline because high taxes cause economic activity to decline.
Now, all things being equal, I believe that lower tax rates are better for the economy. But the problem with tax cuts is that they don't always work to revive an economy. It has to do with the state of the economy when the cuts are implemented. I am not suggesting that taxes shouldn't be cut, but mainstream supply-side economists equate them with stimulus: the more cash in consumers' hands, the more they will consume. Yes, this is a kind of Keynesian stimulus from economic conservatives of the Neoclassical school of economics, such as Mr. Laffer.
If the supply-siders believe that these tax cuts will result in a sharp boost in GDP, I believe they are mistaken. Since the first round of tax breaks from the Recovery Act ($243.4 billion) did nothing to stimulate the economy, another tax cut will yield the same results.
Presently taxpayers are reducing their debt and increasing their savings. Most taxpayers will apply the tax relief to their existing debt or add to savings. Thus, such stimulus will most likely not result in a massive shot in the economy's arm from consumers that the Bill's sponsors expect. What it will do is help repair the economy and lay the foundation for future economic expansion. By paying down debt consumers are regaining their financial security. And, by saving for their future, they are providing the capital that is necessary for future expansion after the scourge of malinvestment from the Fed's credit binge has been resolved. Until deleveraging is completed by consumers and financial institutions, the economy will go nowhere.
Another fallout of the payroll tax holiday is that it may actually increase unemployment. Bob Murphy at The Mises Institute gives a good analysis of the point. If the tax holiday had gone to employers instead of employees it would have resulted in increased employment because the employer now has more money to spend on employees. On the other hand if it goes to employees, they are getting an automatic wage boost. Whether the employee spends it or not is beside the point. What happens in the economic sense is that because of the rise of wages, more folks want to work so the pool of potential employees increases but jobs don't. Thus the number of unemployed has grown.
Tax cuts are always good in the long run. In the short run, unless the government cuts spending, the result of tax cuts will be a higher budget deficit which will divert more capital away from productive uses to service the debt. The only win-win for the economy and we taxpayers would be if the government were to cut spending equal to the deficit. What is the likelihood of that happening?
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These types of analyses always bug me because they assume this country is a closed economic system. In the real world, it's just not. If the stimulus works, it is likely to stimulate more jobs in China than it will here, because its still cheaper to produce the goods Americans buy there and the yuan is held artificially low.
Any analysis that assumes this country is a closed economic system is just GIGO -- garbage assumptions in, garbage conclusions out.
Plus there is a complete failure to account for expanding or contracting debt. See Steve Keen's debt-watch.
This kind of debate is really meaningless in this artificial context.
I'll buy higher calibre weaponry and more ammo.
Actually, I think I really will.
All the tax decreases to lower SS tax and the continuation of the Bush tax cuts we're wiped out by oils 4% move just this week. What a fricking joke. Just look back to Jan '09 when oil was $32 barrel vs. Jan of '11 at presumably $90+. Only difference is $100B lower GDP per dollar increase? This is just ludicrous. Will there ever be an honest assesment of our situation or lies all the way til we explode?
""If the tax holiday had gone to employers instead of employees it would have resulted in increased employment because the employer now has more money to spend on employees." - and why exactly is that? Is there any evidence of this?
Because it sound to me like the dumbest think outside of CNBC propaganda echo chamber. Do employers treat employees as if they were employerss girlfriends? Yeah, if i had more $$ i'd buy my GF a bigger diamond. But if I have my business running just fine, why would I suddenly start hiring? Out of goodness of my soul? Out of charity?
The trick is to make taxes "flat" or at least more fair than they are now. Of course, Steve Schwartzman will never go for that, his income is taxed @15%, bilionires on arverage pay 17% of what IRS is able to find (I'm sure large chunks of income are hidden or taxed at laughable rates like GOOG foreign income @1.5%) Make everyone pay 20 or 25%, regardless of the source, and we'll have another boom.
BTW, high tax raets are not necessarily impediment of high growth: during the 1950s top tax rates were 89%, and growth reached 10% for a couple of years.
If someone cut my tax i'd buy more gold and champagne.
i think that would help the economy... a bit.
"Since the first round of tax breaks from the Recovery Act ($243.4 billion) did nothing to stimulate the economy, another tax cut will yield the same results."
Confusing mickey mouse tax "credits" for mal-investments with genuine tax cuts.
Whatever way you cut it, we arrive
at the same place. $200B of new stimulus
or so. Coffee money. What's suspicious
is the wall street jagoffs that marked
GDP up to 3 or 4% on this pittance.
I realize they're bagholders, but........
First of all IF I cut your pay two years ago, and I don't cut it today, I am not cutting your pay again, Right? If I cut my mortgage payment two years ago and leave it the same today as I have been paying, I am not "cutting my mortgage payment", see?
So why do you ----with a name like econophile--- buy into the destruction of language that the left has managed to accomplish?
The continuation of your pay, or any other financial transaction at the same rate today as it was yesterday, is neither an increase nor a cut, so the continuation of a tax reduction is not a "tax cut", see?
Puts your entire post into a suspicious light.
a,
your point that a continuance of the status-quo is no-more/no-less that just that: a continuance... is sound.
but if each year they threaten to cut that pay, then don't... does that make it different? (if a tree falls in the woods... :^)
i dunno. i believe the taxes would have been effectively increased (expired) were it not for the power re-balance in november, so, because the threat was very real, the 'lack of change' was actually a 'change averted'.
it is all perspective, but i don't think econophile is being disingenuous.
I share anony's frustration with the language employed these days...always have.
I don't think he was being disingenuous either...but I can see why it would pique someone...it does me...LOL.
Not to divert the thread but another one I've always come unhinged about is when the discussion of tax cuts come up.
It is said "how are we going to pay for a tax cut?"...the absolute pinnacle of an elitistist thought process.
One doesn't "pay" for a tax cut...the government just takes less out of the real economy through taxation. It also means it has to shrink it's operations in order to balance their checkbook.
Just like we do.
This "inartful" language dodge is the result of baseline budgeting the author touches on. The premise is, the government can never do with less, even though everyone in the real world has to. Carried to it's logical conclusion it means that government is all that matters...everything and everyone else is secondary to it's wants, needs & desires.
Merry Christmas to all!
SeeYa
Ditto on the "pay for a tax cut" bullshit that one day I even saw the WSJ use in one of their Ed/ops.
If they can pervert the language we use to communicate with onw another AND the people are too sloppy in their own usage, or uneducated to understand what is happening, they win.
Whenever I see it, I call it.
I hope you do as well.
++
Eco,
Best read of the day- not just this site, but any of the sites I visit on a daily basis.
To answer your question (which was rhetorical, I'm sure): they will never stop the spending. This is not a revenue problem- this is a spending problem.
Exactly. But how do we cut spending without a bit of civil unrest in this entitlement society mindset?