Why tax cuts might not rescue the economy

Tax cuts work when they stimulate consumption. President Bush's $150 billion tax cut didn't do this and any tax cuts that President Obama puts in place aren't likely to stimulate people to spend if they are worried about losing their jobs.
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Some tax cuts just go straight into the piggy bank.

Tax cuts work when they stimulate consumption. President Bush's $150 billion tax cut didn't do this and any tax cuts that President Obama puts in place aren't likely to stimulate people to spend if they are worried about losing their jobs.

About a year ago, President George W. Bush asked for and got $150 billion in tax cuts to help stimulate the economy.

It doesn'ꀙt seem to have worked so well.

And still, a lot of folks across the political spectrum are pushing for more tax cuts to help kick-start the economy once again.

Tax cuts didn'ꀙt save us then and won'ꀙt save us now, for a couple of simple reasons.

First, some background. Recessions are caused by one thing and one thing only: a fall in aggregate demand. If the whole lot of us are spending less than before, the economy slides into recession.

Falling aggregate demand can be caused by any number of things 'ꀓ the bursting of an investment bubble, a sharp drop in government spending, or a turn in the business cycle. We seem to have hit two out of three at present.

Critics of President Obama'ꀙs plan to put a lot of money into infrastructure investments 'ꀓ roads, bridges, public facilities of all kinds 'ꀓ argue, with some justification, that it will take some time for that kind of investment to trickle down in the form of a healthy economy.

So they trumpet for tax cuts, because despite having lower taxes than any place except maybe Mexico and Somalia, taxes apparently are continuing to choke the lifeblood out of the American economy. (Never mind that the places with the lowest tax burdens tend to be the least nice places to live.)

Tax cuts can work. If taxes are too high, they will choke off economic activity. If demand is sagging, putting more money in people'ꀙs pockets may encourage them to go out and spend, spend, spend.

And there'ꀙs the catch.

You may recall W.'ꀙs plaintive pleas for all of us to spend our stimulus checks pronto. However, then as now, what most people say they'ꀙll do with a small windfall like that is either save it or pay off debt.

That'ꀙs not bad for the economy; banks will have more money to lend if people either save or pay off debt, which would decrease the cost of credit and theoretically spur economic activity.

Theoretically, because that only works if consumers and businesses have the expectation of borrowing more money.

However, at some point, business isn'ꀙt borrowing because people aren'ꀙt buying so there'ꀙs no need to invest in new plants and equipment. (It'ꀙs for this very reason that business needs a tax cut least of all.) Meanwhile, consumers aren'ꀙt borrowing as much because they'ꀙre trying to cut expenses as they live in fear of losing their jobs.

So for a tax cut to work, it has to spur consumption, and the last one didn'ꀙt and this one probably won'ꀙt either.

The only people who likely will spend more would be the poorest of the poor, assuming they get anything from a tax cut. And they'ꀙre more likely to spend at discount stores such as Wal-Mart, which, at last count, gets 80 percent of its merchandise from China. That won'ꀙt do much to get American factories humming again.

So a tax cut isn'ꀙt any more likely to get the economy lumbering ahead than is infrastructure spending. And it carries the added cost of making the federal budget deficit grow even bigger, with little to show for it at the end but an ever-higher percentage of the budget consumed by interest on the debt.

The quickest way to juicing the economy might be buying up so-called toxic assets from financial institutions, but that rewards the idiots who made all those bad loans. In the brave new world of Obamerica, that'ꀙs a moral minefield we shouldn'ꀙt be dancing on if we don'ꀙt want this to happen again.

The new President will have to include some tax cuts in his economic package just to get enough Republican votes to get anything done. But as much as possible, Obama should stick to his guns and aim for an infrastructure package, not to fix the current economy, but to grease the wheels of prosperity down the road.

Only two things actually make the economy grow: population growth and gains in productivity. The former carries a lot of costs; the second is the only real fountain of prosperity.

Infrastructure spending 'ꀓ human and physical 'ꀓ boosts productivity by creating a better-educated, more creative work force.

This kind of investment aids productivity by reducing transportation costs. Bad roads and the like cost consumers and businesses time and money. Tragically, we'ꀙve already seen what bad bridges can do.

Infrastructure spending can lower the impact of the economy on the environment, something the market by itself cannot do. If we could get sewage treatment for all the homes along Hood Canal, for example, we could probably get fish back in the Puget Sound again.

Tax cuts carry none of these benefits, all of the costs, and won'ꀙt fire up the economy any quicker.

Technically, the definition of insanity is doing the same thing over and over again and expecting that next time, it'ꀙs going to work. But that won'ꀙt stop most of the tax-cut tenors from continuing to sing the same old tune.


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About the Authors & Contributors

T.M. Sell

T.M. Sell is professor of political economy at Highline College.