George Bush looks like he’ll try to stick to his promise about cutting income tax rates, but his team’s recent justifications, while politically expedient, are obscuring the real case for tax cuts.
Given that the U.S. economy is showing signs of slowing, the Bush team is suggesting that tax cuts will provide a stimulus for renewed growth by giving consumers more money to spend. The fact is, a tax cut won’t stimulate the economy by increasing consumer demand in the short term, but by reducing barriers to productivity. In addition, tax cuts will not “give” people more money to spend – it will simply take away less.
The “consumer stimulant” argument supports the false but popular assumption that demand is the prime mover of the economy. The economist Keynes established this idea – that consumption, not production, is the key to wealth and the government must “stimulate” that consumption through fiscal policy. In reality, “demand” without production will achieve nothing – except perhaps bad debt. Production must precede consumption.
The proper argument in favor of tax cuts is twofold: the primary argument is moral – that people who earn wealth have the moral right to keep it. For a “moderate,” Bush has surprised me favorably by essentially saying just that (for the full moral argument, consult “Atlas Shrugged,” by Ayn Rand).
The secondary argument is economic — an income tax is a disincentive to earn taxable income, while cutting tax rates reduces disincentives to the productive activities of working, saving, investing and risk taking. So lower taxes lead to greater economic production, by encouraging the “supply” side of economics. “Demand”, on the other hand, always seems to take care of itself, led by supply, as I’ve learned by observing my wife’s shopping habits.
There are two arguments that Bush’s political opponents are making against tax cuts.
The first is that taxes must remain high in order to pay off the national debt. This argument doesn’t hold, for the U.S. budget remains like a bloated whale, with about ten feet of fat to cut before we reach the meat. And how many of these tax cut critics are asking for significant government spending cuts to pay of debt? Approximately none.
The second argument is improvised – some claim that Alan Greenspan’s recent rate cut will solve everything, so there’s no “need” for tax cuts. Unfortunately, the yield curve remains inverted, suggesting the Fed is still “tight,” just less so. Beyond that, the Fed’s key task is to avoid inflation, not fiddle with economic growth, despite Keynes and Congress’ claims to the contrary.
There is one way that Bush’s tax cuts could actually harm economic growth in the short term. Economic forecaster Richard Salsman alerted me to the danger of Bush’s promise of tax cuts deferred into the distant future, rather than coming into immediate effect. This could result in people waiting until the cuts take effect, thereby delaying productive activity and the reporting of income from the present to future periods. Fortunately, it appears that Congressional leaders are willing to fight against opposition for tax retroactivity, allowing supply-side growth to begin immediately.