The Stimulus That Won't

President-Elect Obama and major players on both sides of the aisle in both houses of Congress are rapidly lining up behind an ‘economic stimulus plan.’ Unfortunately, none of the political power brokers seem to have the slightest inkling of what will effectively stimulate the economy.

SmartMoney provides a brief description of the $300 billion tax cut portion of Obama’s stimulus plan. Almost nobody is paying attention to the fact that the package increases government spending by about $600 billion. The Keynesian argument that increasing government spending always stimulates a bad economy seems to be simply taken for granted by most of the political class and the media. Also, few are questioning the other garbage that federal legislators are licking their chops to include in this package.

Moreover, nearly all of the tax breaks being proposed (including those championed by Republicans) are either temporary, wealth transfer payments disguised as tax cuts, or both. In effect, the proposed tax cuts are not much different from those included in last year’s stimulus package, which is generally conceded to have failed to stimulate the economy. Many (including Republicans) are saying that the reason for this is that the package wasn’t big enough.

Let’s parse that reasoning a bit. Distributing a wad of cash that we didn’t even have in a ‘rebate’ to ‘taxpayers’ (including many that didn’t pay taxes) didn’t work because we didn’t use a big enough wad of cash. I guess that makes sense in the weird world of politics, but it makes little sense in the real world.

In truth, every dollar of ‘rebate’ must come from somewhere — and that somewhere is the American taxpayer. It is a tax that must be paid sooner or later; in inflation, decreased interest on savings, eventual tax increases, lost opportunity costs, etc. Any stimulus ‘tax rebate’ results in higher taxes, whether those taxes are visible or hidden. (Most politicians prefer to hide tax increases.)

Tax rebates move money around, but they cannot produce any real economic improvement. The only thing that actually stimulates the economy is for producers to produce more (or more efficiently) than they are currently producing. The only thing the federal government can do to effectively make that happen is to provide permanent incentives, in the form of getting out of the way of producers and taking less of what they earn. Producers tend to sit tight when such incentives are only temporary.

I have been deeply disappointed by some of the tax cut plans being bandied about by ‘conservative’ politicians and wonks. One suggestion, for example, is a tax holiday from payroll taxes (Social Security and Medicare) lasting from six to nine months.

Employee gross income is assessed 12.4% Social Security tax and 2.9% Medicare tax, for a total of 15.3% payroll tax. However, employees only see half of that (6.2% + 1.45% = 7.35%) coming out of their pay because employers are required to pay the other half.

Cutting payroll taxes for a few months, the argument goes, would stimulate the economy because employers (i.e. producers) would be able to put that 7.35% of payroll taxes that they now pay to more productive use. Also, it is argued, employees would freely spend their increased 7.35% take home pay. A side benefit noted by some conservatives would be that employers and employees alike would suddenly discover just how oppressive payroll taxes really are, possibly sparking a revolt when the tax holiday concludes and taxes are increased again.

Why don’t I like this plan? For starters, the payroll holiday would only be temporary. As I mentioned above, temporary tax cuts provide no real incentives for producers to produce more or better, thus, temporary tax cuts do not effectively stimulate the economy. Ergo, this plan would not improve the economy.

Another problem is that Medicare and Social Security are already facing future financial collapse. Giving taxpayers a holiday from paying Social Security and Medicare taxes while continuing to provide (and promising to provide) the same level of benefit from these programs is insane. The promoters argue that the plan would produce enough stimulus to eventually recover the taxes lost during the tax holiday, but per my previous paragraph, that won’t happen.

As ludicrous as the payroll tax holiday is in a fiscal sense, it is no more absurd than every other ‘tax cut’ under serious consideration by federal power brokers. Giving ‘income tax rebates’ to people that never paid income taxes (chiefly non-producers) is just as ridiculous, for example.

If the federal government wants to stimulate the economy, it should immediately and permanently cut tax rates on actual producers. Business and investment tax rates should be cut across the board. Even this will be only partially effective in stimulating the economy unless the federal government insists on fiscal restraint and spending cuts to match the tax cuts.

Unfortunately, nobody with political clout is even willing to think about actual permanent rate cuts, let alone talk about them in a serious fashion. In the current political climate in Washington, ‘permanent tax rate cut’ is the phrase that must not be mentioned. Heretics will be punished. Ditto that when it comes to cutting federal spending.

This leaves me to believe that most people with federal political power: a) are ignorant of how the economy actually functions, b) have little interest in actually stimulating the economy, or c) both of the foregoing. At any rate, ‘economic stimulus’ is a term being used today to further purposes entirely different from what most people understand that term to mean.

It appears inevitable that whatever gets passed in the name of economic stimulus will work pretty much like last year’s stimulus package. Only worse.