The Entrepreneurial View #466
Economic "Stimulus"?
by Raymond J. Keating
With the economic waters getting rougher - and many now expecting a recession in 2008 - there's a good deal of talk about an "economic stimulus" package coming out of our nation's capital.
Can government actually "stimulate" the economy away from or out of recession? Of course not.
Unfortunately, many have been laboring under this misnomer since John Maynard Keynes misled the economics profession regarding government's so-called management of aggregate demand, and President Franklin Delano Roosevelt got it wrong on the political and policy fronts in the 1930s. Keep in mind, while FDR gets credit in some circles for guiding the U.S. out of the Great Depression, in reality, the U.S. economy did not recover until after World War II.
The best government can do is establish the proper policy climate in which entrepreneurs and investors can take risks, grow the economy, and create jobs. It is private sector investment, innovation, invention, efficiency and productivity that spur the economy forward, not government.
Therefore, many of the "economic stimulus" ideas being kicked around right now will either do nothing to boost the economy, or will actually inflict further damage.
Some, for example, argue for more government spending. Various politicians and analysts have called for doling out more bucks on big government infrastructure projects. Do they really believe that sucking more resources out of the private sector so government can pour more concrete is the answer to a slowdown or recession? That's pretty silly.
Even sillier is the idea of taking tax dollars from consumers and businesses at the federal level, and then handing those resources over to state politicians. So, the expectation is that state politicians will somehow spend free money from Washington in an efficient, pro-growth manner. Yeah, right.
But there are even some bad ideas on the tax front as well. For example, a favorite among politicians is the tax rebate. The government sends everybody - or just lower and middle-income earners - a check in the mail, and then people are supposed to go out and spend that money to stimulate the economy. But tax rebates like this have been tried in the past, and have never enhanced economic growth. That's not surprising when you think about the process. People pay taxes, and then the government sends a bit of those taxes back in one-time checks. There are two possibilities here. First, a taxpayer sends money to Washington, and then the government sends back a small portion. Or, the government takes money from one set of taxpayers, and then cuts a check to others who do not pay taxes or pay far less in taxes. This is nothing but wealth redistribution.
Either way, this is all about government shifting around resources. That's at best a zero sum game, or at worst, a negative due to government interference in the economy. For good measure, there's no evidence that tax rebate recipients go out and spend all of these refunds - as tax rebate supporters hope - as much is saved due to hunkering down in a rough economy.
How about temporary tax cuts, as some suggest? All sorts of temporary tax cuts have been mentioned, including a temporary payroll tax cut or temporary tax incentives for investment. The problem here is the "temporary" part. The effect of a temporary payroll tax cut is much the same as a one-time rebate check. And temporary investment incentives, at best, shift around the timing of investments. More likely, the temporary nature means that few businesses and investors will take full advantage due to the inherent uncertainty.
Finally, there is the crowd that does not bother with fiscal policy at all, and instead pushes for the Federal Reserve to stimulate the economy through reductions in short-term interest rates. But monetary policy is ill-equipped to fine tune the economy. When the Fed focuses on boosting economic growth through such policy changes, it necessarily loses focus on the job it is designed and supposed to do - maintaining price stability. When the Fed keeps inflation low, it provides a necessary foundation for economic growth. When it goes off on an escapade trying to fine tune economic growth, it accomplishes little on the economic growth front, while doing substantive damage due to escalating inflation risks.
So, what can Congress and the White House do?
Permanent, substantive, broad-based tax and regulatory relief remain the most reliable and effective means for government helping the economy.
At the very least, the growth-oriented Bush tax cuts from earlier in this decade - such as lower personal income, capital gains and dividend tax rates, expanded small business expensing, and elimination of the death tax - must be quickly made permanent. That will be reassuring to entrepreneurs, investors, businesses and consumers.
But more is needed in terms of tax relief. Why? Keep in mind that since World War II, whenever total federal revenues have topped 18.5% of GDP, the economy has suffered. The same goes for whenever personal income tax receipts exceeded 8.5% of GDP. Where are we now? The final numbers for FY2007 placed total federal revenues clearly in the danger zone - at 18.8% of GDP. Meanwhile, individual income tax receipts were at the tipping point - 8.5% of GDP. Looking ahead, the latest projections from the Congressional Budget Office peg total revenues as a share of the economy in the 18.6%-19.2% range from 2008 to 2010, with individual income tax receipts over the same period coming in at 8.9%-9.0%. If these projections are in the ballpark, that's bad news for the economy.
Beyond making the Bush tax cuts permanent, income tax rates need to be reduced further under both the personal and corporate income taxes. U.S. corporate tax rates are particularly high compared to much of the world. Allowing all businesses to choose between expensing or depreciating capital investments also makes sense. Eliminating individual and corporate capital gains taxes would be ideal - making the U.S. a magnet for growth-generating, job-creating capital - or at least indexing gains for inflation would be quite positive.
It is important for policymakers to understand that the consumer rarely leads the U.S. into recession. Instead, it's usually about business investment. Keeping tax and regulatory burdens low, protecting property rights, and maintaining price stability - that's the basic formula for economic prosperity, in the short term and over the long haul.
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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.
