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 Congressional Budget Office estimate of the impact of the bill on the federal budget. Its assumption is that what isn’t taken by the government is left in our pockets to spend. It claims there will be $780.4 billion of new stimulus. But the reality is that isn’t quite accurate.
The government programs into its budget the revenue that would have been received as the result of the expiration of the Bush tax “cuts” as its “normal baseline for those budget years (2011-13). The way it sees it is that if the taxes don’t go up as projected, it’s a tax “cut” because it reduces projected revenue from its 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 aren’t 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 it 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 vs. new tax increases would be about two-thirds of what the CBO had estimated in its 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 with 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: $339.5 billion has been spent 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 that 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 that stimulate 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 Federal Reserve 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’m 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 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 most likely will 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 that 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?
— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.
Comments
