Cut Taxes for the Right Reasons

Mises Institute ^ | February 16, 2009 | Robert P. Murphy

[djsherin]

In their zeal to oppose the lunacy of the so-called "stimulus" plan, many radio talk show hosts and other pundits have fallen into the Keynesian trap. Rather than the politicians spending nearly a trillion dollars, they argue, it would provide much more stimulus if the government gave massive tax cuts. This would "put money back in the pockets of average Americans" and they would go to the mall and "get that money into circulation and boost the economy."

Although the instincts behind such arguments are sound, they often betray an underlying Keynesian mindset. By justifying tax cuts on the grounds that the taxpayers will go out and spend the money, these critics actually concede the entire case. After all, why take a chance on those fickle taxpayers, who might selfishly decide to pay down some debt or to stick the extra cash under the mattress? If buying stuff is the way to promote recovery, then nobody can top the DC politicians.

In conclusion, the critics of the nearly trillion-dollar "stimulus" plan are certainly correct to call for tax cuts rather than more government spending. However, many of these critics couch their justifications in ways that actually prove the superiority of government spending. A correct analysis shows that it is better to let taxpayers keep more of their money, even if they use 100% of the savings to pay down debt. There is nothing magical about consumption spending, and in fact it was overconsumption that got us into the present mess.

[djsherin]

Note: his point isn't that tax cuts are bad, but that they are often wrongly justified.

[djsherin]

ping

[org.whodat]

There is nothing magical about consumption spending, and in fact it was overconsumption that got us into the present mess.

That and easy credit!! and depressed wages!!

[ProtectOurFreedom]

You have to get to the end to read the money quotes:

First is the simple moral argument. That money was earned by the taxpayers, and so prima facie it is always a good idea to take (i.e., steal) less from them.

Second there is an incentive argument. Especially if the tax reduction comes in the form of lower marginal rates (rather than lump-sum rebates), then individuals have the incentive to produce more. Notice that this is the exact opposite of the standard Keynesian analysis. In other words, the pragmatic argument for tax cuts isn't to give consumers more money to go buy stuff, but rather it's to give producers the incentive to go make stuff.

IMHO, it is always about reducing marginal tax rates to create fresh incentives. If you let people keep more of what they earn, they will work harder, strive harder to advance and stay motivate. What in life is more demotivating than a gargantuan government that literally sucks the life out of you?

[expatpat]

I believe that tax cuts work because they improve the velocity of money. We have enough M in the economy but the velocity/multiplier is around 1.0, which means that increased stimulus spending will not work. We need to get the money moving again, so that V is above 1.2, and tax cuts help there.

[maxsand]

FILE YOUR EXTENSION...

[Pietro]

I think a more prudent tax cut, and this has been pointed out by many pundits as well, would be to cut corporate tax rates and capital gains taxes. Both of these cuts would increase corp spending, thus job growth and ultimately consumer spending and HELLO tax revenues.

[chainsaw]

his point isn’t that tax cuts are bad, but that they are often wrongly justified.

It will take a little finagling but eventually the blacks won’t have to pay any, and you will pay their fair share.

[sickoflibs]

The Peter Schiff/Redistribution Watch Ping. (Washington Bankrupting our Nation by Spending your past, present and future money!)

“The recession is not caused by a sudden bout of irrational anxiety on the part of consumers. On the contrary, our present mess is the fault of the Fed's decision to lower interest rates after the dot-com crash and 9/11 attacks. Alan Greenspan didn't want to deal with a sharp recession then, and so he papered over the problems by flooding the credit markets with cheap money, courtesy of the printing press. This set in motion an unsustainable boom, especially in real estate and Wall Street. Even if consumers wanted to keep their buying habits up the way they had been living during 2002–2006, this would ultimately prove to be physically impossible. China was not going to forever send electronics goods in exchange for claims on McMansions that had no tenants.”

[sickoflibs]

Nice article, I pinged it. I have having another problem to add.

Republicans have become a term democrats used to call them, "Borrow and spend Republicans".. The economy includes a great amount of income redistribution which generally offends us, especially when we feel it is from us to others. We take it as immoral. What about when our elected leaders, led by out president decides things he wants (for his legacy mainly) are emergency items? and they can be added to national debt off-budget? We dont want tax increase we want cuts, the govt takes too much of our money, right? So we justify it as OK. All tax cuts even Brittney Spear's and tax rebates make the economy strong, right?. And so do the invasions, reconstructions, bailouts, stimuluss all necessary to keep us alive, right? (To some they are critical, but to others they are waste) . So we have a republican president that decided he got a blank check from God to spend on anything he wants, endless debt. American is taught they can have big government without paying for it. So we get debt or inflation or both, both are still redistribution, Keynesian( someone gets the government jobs) but in a more dishonest way. But republicans argue that dishonest redistribution is OK, as long as they agree with the spending (like Iraq).

And then we end up with Pelosi and Obama with their own blank check from the liberal God (which happens to be themselves being liberals.) Now Everyone wants their share.

The Republican party is broken, with the country, and I am not sure of the fix.

[uglybiker]

Tax cuts make libs blow a gasket.

That's enough reason right there.

[sickoflibs]

RE “That’s enough reason right there.’

You have to win the argument first and Obama was always polled better on trust for taxes than McCain. In fact Bush was polled low on trust for taxes too. That is pretty bad when people trust Marxists more than republicans on tax issue. I think I know why.

[rabscuttle385]

Tax cuts make libs blow a gasket. That's enough reason right there.

That's a consequence, not a reason.

[djsherin]

I don’t disagree, what I disagree with is the notion that spending drives the economy. Production drives the economy. We don’t want work for work’s sake nor spending for spending’s sake; we want spending on things that actually benefit people, namely whatever they so choose without government intervention, coercion, encouragement, etc.

***...and HELLO tax revenues.***

I’ve always been confused by this. Why is it that we want the government to take in higher revenue? All that means is that government is getting a bigger share. We shouldn’t be justifying tax cuts for the theoretically higher revenues they may eventually raise. They should be justified on the idea that people have a right to their money and that lower taxes allow for more incentive to make money (i.e. be productive).

[Pietro]

"I’ve always been confused by this"(tax revenue)

Becuase we, the US Gov., has incredible liabilities that are not going away, for example SS, medicare, etc.

Whether you believe these expenses are legit or not they are real and will require increasing revenues.

Raising revenues w/o raising taxes is a good thing.

[4woodenboats]

Sounds intriuging. Could you expound a bit for those of us with much more curiosity than technical knowledge?

TIA

[expatpat]

In simple terms, if there is a lot of money out there but no-one is spending it or lending it, then economic activity is nil, no wealth is created. If there is less money available but it is spent immediately someone gets it, then there is lots of economic activity, and every time it is spent someone makes a small profit (including the govt.).

Consider $1000 in a bank. It may just sit there (very low velocity). Or they lend it to a manufacturer to help make his factory more efficient and he spends it on that and then whoever gets paid by him spends it, and so on, so that there are hundreds of transactions before that $1000 gets back to the bank (high velocity, v > 1). In the latter case, many people have put it to good use while in the former case, it might as well not exist as far as economic usefulness is concerned.

Does that help?

[Gondring]

China was not going to forever send electronics goods in exchange for claims on McMansions that had no tenants.

This seems SOOOOOOO obvious. Why is it that so many people can't seem to grasp it?

[4woodenboats]

Yes, that was an outstanding explanation.

Thank You.

[meyer]

The right reason to cut them is that they are way too high.

[djsherin]

A consequence of spending. That needs to be cut.

[uglybiker]

That's a consequence, not a reason.

If you really want to get technical about it, liberal reaction is not so much a consequence as it is an indicator.

When libs come out against a piece of legislation, that can indicate that it is a good idea. How good an idea depends on how shrill and bug-eyed they get.

Somebody with better graphics skills than I could make up a nice graphic to show if a bill is good or not.

You could start with:

Reagan would have liked this!

It's okay. Could be better, but it could be a helluva lot worse.

Has some good points, but still needs work. (RINO reaction and be a reliable indicator, as well.)

Yer kidding, right?

Oh God...

[Pelham]

“I believe that tax cuts work because they improve the velocity of money.”

Velocity fell dramatically after the Reagan cuts resulting in a much faster collapse of inflation than the Fed and Treasury had predicted. People were no longer fearful that the value of their savings would depreciate so they were willing to increase their savings.

[Pelham]

Tax cuts don’t result in increased tax revenues except in the case of capital gains cuts. Rate cuts promote economic growth, which during the Reagan administration were shown to recoup 2/3 of each dollar cut. No Reagan economist ever claimed otherwise. The idea that tax cuts pay for themselves is nonsense not borne out by the evidence.

[djsherin]

I know, I just never understood why we would WANT the government to take in higher revenues and thus make that part of the argument for lowering taxes (even if it isn’t true).

[expatpat]

Can you show me the data?

[Pelham]

It was in a publication I was getting from the Federal Reserve Bank of New York back in the 80s, and I believe the article was written by their then president. They had missed their inflation forecast and it was embarrassing for them. What they found is that the public was smarter than they were being credited for- once the public perceived that government and monetary authorities were serious about fighting inflation then the public was willing to save money instead of spending it as fast as they got it. Velocity fell off a cliff.

I see that the FRB NY has some of their publications online now but they only go back to 1995. You might be able to get their research department to dig up the article, although without a title or date who knows? Unfortunately if I still have the publication it’s in storage where I can’t easily access it.

http://www.newyorkfed.org/research/publication_annuals/index.html

[Pelham]

Well I agree with you. I know why some people say it, it makes the argument for cutting taxes seem painless, and this is a generation of Americans that likes the easy way whenever possible.

Art Laffer shares some blame for this misperception. He knows better, but he routinely lets interviewers say things that mislead the public.

And then we have our radio conservatives who have been spouting this stuff for years. The accurate information isn’t new, the books by Reagan’s economists were published before 1991. A friend of mine has said that if you want to hide something from one of these radio wizards you simply have to put it in a book.

[SecAmndmt]

“Whether you believe these expenses are legit or not they are real and will require increasing revenues. “

What makes you think that the same gov’t that has squandered the social security trust fund & medicare fund, is actually going to start setting aside the surpluses collected from current wage earners?

[expatpat]

I think I found it there, at http://www.newyorkfed.org/education/addpub/monpol/chapter1.pdf.

Velocity did fall somewhat, but only because it had climbed to the very large value of 7 during the 1960-1980 period, for the reasons you mentioned. It only dropped a little, to about 6, which is still high.

At the moment, we are faced with a velocity of about 1 -- we would love to get it even half-way to 6......

[Kellis91789]

“... a bigger share ...” is the point of confusion. You can have a larger tax revenue stream that constitutes a smaller “share” of an even larger GDP.

The Federal Government Budget is $3T and GDP is $13T. If GDP can be grown to $20T while the Federal Budget grows to $4T, I’d consider that a Conservative success. We’d be moving in the right direction, shrinking the share of GDP that goes to government, even though tax reveneus had increased in absolute terms.

We all know it is virtually impossible to eliminate government programs once begun, so our only chance is to keep spending from growing as fast as we grow the economy.

[djsherin]

It’s true that government never shrinks, but that isn’t going to stop me from arguing against its expansion.

While comparing government to GDP, I think it’s important to realize also the government continues to grow even inflation adjusted which means it’s taking up a bigger share of the money supply.

I’m not going to be content with the government’s share of GDP going down if it’s still increasing in size, inflation adjusted. Though I realize I’ll probably never be content.