Romney's Stimulus Plan

I detailed some shortcomings of Obama's economic plan last week. Now let's talk about what should be done instead. Mitt Romney wrote a column last week, detailing his prescription for our economy, and most of it is pretty agreeable. The basic difference between Obama and Romney on the economy boils down to government spending vs. tax cuts (Keynesian vs. supply side economics).

Romney cites empirical research that indicates that a $1 increase in government spending (i.e. a stimulus check) will increase GDP by between $1 and $1.40. $1 in tax cuts, on the other hand, increases GDP by $3. This is a major blow to the Keynesian model.

Why do tax multipliers exceed spending multipliers? Here's the basic idea: tax cuts give people more money to spend, which stimulates demand (the essence of Keynesian prescriptions) but unlike increased government spending (which increases demand in the same way), lower taxes encourage investment, which generates jobs and more production. For example, let's say Obama lowered payroll taxes, effectively lowering the cost of employing people. Using our basic supply/demand curve, we know that lower labor costs will increase demand for labor. Workers will take home more of their pay, which they will spend, driving up demand for goods and services, and companies will hire more people.

Romney agrees that infrastructure projects should be a high priority, but notes that the economic benefits of these projects are no where near immediate because these projects take a while to complete. Romney warns against excessive regulation and the Employee Free Choice Act that would "virtually impose unions on small business by eliminating the right of workers to vote by secret ballot in the workplace. This 'card check' payback for the AFL-CIO’s support of the Democrats would devastate business formation and employment".

Romney does support government spending on "basic research" for technologies that will make us more energy dependent. I maintain my basic argument on this subject: while the impact on global warming is debatable and energy independence would be great, this government spending is not likely to help the economy in the long term and definitely won't help in the short term.

All choices in government require trade-offs:

There is a danger that new spending and deficits will lead to runaway inflation, flight from the dollar, and another economic crisis. It is essential, therefore, that Congress and the president commit to reform entitlement spending as soon as the economy recovers. With the footing of our long term economy at risk, with entitlements already reaching 60 percent of federal spending and with baby boomers nearing retirement, this can be delayed no longer.

Unfortunately, elections have consequences and Obama is likely to choose ideology over sound economics.

More Expensive Energy

President elect Obama's plan for the economy seems to center on two tactics: a huge ($1 trillion) stimulus package and "investment" in new energy sources and more fuel efficient technology. Neither encourages production and both are extremely inefficient uses of our tax dollars.

A big stimulus check, which will only go to low and middle-income Americans, is intended to stimulate demand for goods and services - "priming the pump", if you will. Classic Keynesian economics. Unfortunately, there are easily foreseeable problems with this plan. Economists favoring this approach are counting on a huge multiplier effect: you spend your check to buy x, the guy who sold you x uses the profits to buy y, and so on. The increased demand for goods and services caused by the stimulus is supposed to encourage more production of goods and services to meet this demand. However, in these economics times, low and middle-income people will likely save the money or use it to pay down debt instead of running to Best Buy. Saving and paying down debt eliminates the multiplier effect, does nothing to stimulate the economy and increases the national debt.

The trillion dollars has to come from somewhere and it is likely to come from higher taxes on people making too much to get a stimulus check in the first place and from higher corporate taxes. Aside from the injustice of this income redistribution, higher taxes on the most productive workers and corporations discourages production and job growth. Tax cuts also get more spending money in people's pockets, but have the added benefit of encouraging production and job growth.

Obama plans for huge spending increases on alternative fuels and green technology. He claims that these green jobs will boost the economy. Absolutely wrong headed. We can argue about the wisdom of spending billions on policies that will have zero effect on the climate another time. If Obama's green policies are about global warming, then he should sell them as such, but don't tell me they are good for the economy. Markets are very good at finding the best price for energy. For our cars, you can't beat gasoline. However, our government pays huge subsidies to add ethanol to the mix. Subsidies for alternative energy increase the amount we as a country pay for energy. Every extra dollar we spend on energy is a dollar we can't spend on education, health care, or a hat, a big ol' hat with a bill that goes buuuup (sorry, but this blog has been movie reference deficient of late).

Investing in green jobs is simply taking the tax payers' money and spending it on things they wouldn't choose to spend their own money on. Green jobs do nothing to add to the production or standard of living of the American people. Paying a researcher $100k a year to find new ways to increase our energy costs does not help the economy. It's little different (from an economic perspective) from paying someone to dig ditches and then fill them in again. Sure, you created a job, but you had to take money from other people to do it and you gave them nothing back in return.

Tax Cuts for the Rich

Here are the new figures on the distribution of income taxes for 2007. Ever wonder why Republicans continue to propose "tax cuts for the rich?" Maybe it's because they are the only ones paying taxes.

In case you can't read the graph, the top 1% pay 39% of all income taxes, 2%-5% pay 20%, 6%-10% pay 11%, 11%-25% pay 16%, 26%-50% pay 11% and the bottom 50% pay just 3%. The top 50% pay 97% of income taxes! What is there to stop the majority who pay little in income tax from voting to increase taxes on those making more? Politicians then use that money to transfer it to the bottom 50%, effectively paying them for their votes.

Whenever the media talks about tax cuts they show how much top earners save compared to the pittance received by the low earners, but they never show how much those people pay to begin with. Bush's tax cuts reduced the middle fifth's effective tax rate from 5% to 2.9%. They got a much larger percentage cut than the richer tax payers, but the total amount saved was much smaller.

Bottom line: to cut taxes, you have to cut taxes for the rich (who provide almost all the jobs, by the way) or you won't have much of a tax cut.

The Big Stimulus

Sadly, I will be getting a check from the government as part of the bipartisan stimulus package (assuming the Senate passes the bill). Unfortunately, I don't make enough to be excluded, but I'll gladly take the money. I'm conflicted on this whole idea. I will never complain about the government letting us keep more of our own money. However, that's not exactly what is happening and that's certainly not the motivation for this package (at least from the Democrats).

The first problem is that this legislation gives two false impressions: that our economy is in the tank and that the government can fix it. We are not in a recession. A recession is two consecutive quarters of declining GDP. We haven't even had one quarter. However, there are real fears that 1st quarter '08 will show a shrinking economy and people in Congress like to get reelected. A stimulus package worth billions is a band-aid to a multi-trillion dollar economy. The market has to correct from time to time.

The second problem is that people making too little to pay taxes are receiving this "tax rebate." Those with adjusted gross incomes above $75k ($150k for a couple) get nothing. So the government is effectively taking money from those who pay the vast majority of income taxes and distributing it to the middle and lower class (the top 25% of earners pay 83% of all income taxes, the bottom 50% pays only 4%). Not only have the lower class done nothing to earn this money, but they are more likely to use it to pay down debt instead of stimulating the economy by spending it. Noble Laureate economist Milton Friedman (pictured) argued that consumers will increase spending in response to permanent tax cuts, but would save most of any temporary tax cut.

I'll never argue against a tax cut, but making the Bush tax cuts permanent would have been a much better idea.

Taxing the Rich

A recent New York Times article makes the tired liberal argument that the rich do not pay "their fair share" of taxes. The American Thinker rejects this argument based on actual IRS statistics. About half of tax returns are for people making less than $30,000 (Adjusted Gross Income). They pay between 3.5-4.5% in taxes (maybe a $1000 a year). Those making $200,000 (AGI) or more make up 2.7% of the population, pay over 20% (at least $40,000 a year) in taxes and contribute 51% of all income taxes. Sounds like more than their fair share to me. The top 2.7% pay at a minimum 40 times as much as the bottom half. Doesn't it follow that the ones paying the most tax should benefit the most from tax cuts? It would be nice if the left would stop trying to use class envy to get votes.

Taxes

In honor of tax day I'm sharing a parable about tax cuts that has spread around the internet. Democrats are fond of saying that any tax cut mainly benefits the rich. There's more to the story...

Let's put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for dinner. The bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing. The fifth would pay $1, the sixth would pay $3, the seventh $7, the eighth $12 and the ninth $18. The tenth man (the richest) would pay $59. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20." So, now dinner for the ten only cost $80. The group still wanted to pay their bill the way we pay our taxes. So, the first four men were unaffected. They would still eat for free. But what about the other six, the paying customers? How could they divvy up the $20 windfall so that everyone would get his 'fair share'? The six men realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to eat their meal. So, the restaurant owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so: the fifth man, like the first four, now paid nothing (100% savings). The sixth now paid $2 instead of $3 (33% savings). The seventh now paid $5 instead of $7 (28% savings). The eighth now paid $9 instead of $12 (25% savings). The ninth now paid $14 instead of $18 (22% savings). The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to eat for free. But once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man "but he got $10!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than me!" "That's true!!" shouted the seventh man. "Why should he get $10 back when I got only $2? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!" The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being successful, and they just may not show up at the table anymore. There are lots of good restaurants in Europe and the Caribbean.