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Larry Kudlow: Washington’s War on Investment

Some Democrats underestimate the economic power of saving and investment

By Larry Kudlow |

Will higher tax penalties on investment really spur jobs and faster economic growth? Most commentators would say no. It’s really a matter of economic common sense. But Treasury Secretary Tim Geithner says, yes!

Larry Kudlow
Larry Kudlow

Speaking to a group in Washington last week, Geithner said that extending tax cuts for the wealthiest Americans would imperil the fragile economic recovery. He argued that government needs the revenues from those top-end tax hikes. So failure to raise taxes would harm growth. And then he went on to say that the trouble with the wealthy is that they save more of their tax breaks than do other groups.

OK. Are you confused now? Most people would be.

Let’s start at the top. The coming tax bomb would raise the top marginal tax rate on capital gains to 20 percent from 15 percent, on dividends to 20 percent (or perhaps all the way to 39.6 percent) from 15 percent, and on top incomes to 40 percent from 35 percent. Meanwhile, the estate tax could go as high as 55 percent.

Now, it is indisputable that capital gains, dividends and estates are essentially investment. What’s more, most successful earners who pay top personal tax rates are, by nearly all accounts, the folks who are likeliest to save and invest.

But Geithner is suggesting the economy doesn’t need more saving. This thought was echoed by Jared Bernstein, a top White House economist, who told me in an interview that the saving and investment multipliers for economic growth are way below the stimulative effects of government transfer payments, such as more aid to state and local governments and further extensions of unemployment benefits.

Echoing that thought, the Senate last week voted to approve $26 billion in aid for state and local governments — partly funded, by the way, by an $11 billion yearly tax increase on the foreign earnings of American multinational corporations. Here, too, a tax on profits is a tax on investment. The Senate also rejected an amendment by Sen. Jim DeMint, R-S.C., that would extend all the tax cuts enacted under President George W. Bush.

In effect, pulling all this together, the position of the Democratic Party in power in Washington is that transfer payments (taxing and borrowing from Peter to pay Paul) are good for growth and that investment is bad.

Go figure. I guess it’s a battle between the demand side and the investment, or supply, side.

The great flaw in the thinking of the Democrats is that they are ignorant of the economic power of saving and investment. Saving is a good thing. Stocks, bonds, bank deposits, money-market funds, commercial paper, venture capital, private equity, real estate partnerships — all that saving is channeled into business investment. And whether that capital goes into new start-ups or small businesses or large firms, it finances the kind of new investment in plants and equipment and software and buildings that ultimately creates jobs and family incomes. And that, in turn, spurs consumption.

But pulling out just one dollar from the private sector and rechanneling it through the government as a transfer to someone else creates nothing. At best, it’s a safety net. At worst, it may damage private-business activity and actually reduce employment.

Without saving, there can be no investment. And without investment, there can be no enhanced productivity, which is the ultimate source of long-term prosperity and wealth.

Now, there are some Democrats who understand this. Sens. Evan Bayh, D-Ind., and Kent Conrad, D-N.D., among others, support an extension of the upper-end tax cuts precisely to increase investment incentives that will create jobs. Bayh and Conrad often refer to the President John Kennedy tax cuts that lowered marginal rates across the board for successful earners and businesses. They correctly worry about small-business job creation in this process. And they have moved from the demand side of today’s Democratic Party to the supply side of the Kennedy era.

Bayh and Conrad have the story exactly right. And Treasury man Geithner has it fundamentally wrong.

Geithner tries to make a deficit-reduction argument, saying that extending tax cuts for the wealthy would cost $700 billion over the next 10 years. But the real debate in advance of the Erskine Bowles deficit commission, which will restructure budget and tax reform, is about a one-year extension of the Bush tax cuts. That’s priced at $30 billion by the White House, about the same as the new bill to aid state and local governments. Which policy would help growth more?

My answer is to keep the incentives for investment. Or find spending cuts immediately to cover both options. That would restore even more confidence.

We might also be surprised when the growth- and revenue-increasing benefits of lower investment tax rates pay for those tax cuts in the future — just as they have in the past.

Larry Kudlow is the founder and CEO of Kudlow & Co. LLC, an economic research and consulting firm in New York City, and host of CNBC’s Kudlow & Company. Click here for more information, or click here to contact him.




comments powered by Disqus

» on 08.08.10 @ 05:26 PM

We have already seen this movie and it didn’t have a good ending. Crazy-cons trying to extend tax subsidies for the rich by piling on more debt. “Dont tax , keep spending”.
  H.W. had it right when he labled it “voodoo economics” . You cant be for extending these subsidies and a pay as you go proponent at the same time.
  This fight should be interesting and will reveal who is truly serious about reducing the deficit .

» on 08.14.10 @ 01:41 PM

When the choice is between Keynesian economics and the Laffer Curve…I’ll take the Laffer Curve based on the failure of Keynesian policies every time they have been tried.

The only thing I trust about November is that it will help to re-establish the checks and balances to Congress.  Heaven help the Republicans if they do not starve the financial cancer that currently exists. They must cease the bailouts of failed states,public employee unions, Wall Street, and the health care plan first needs to be gutted and defunded then we can get on with the business of America and begin to heal the damage these people have done.  The screaming and caterwauling will be loud and incessant but they need to devastate the economic policies and programs that Obama has foisted on our nation.

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