Peter Ferrara takes apart Obama’s claim to be offering tax cuts. No actual rates will be cut in the making of the President-elect’s plan. So, the plan won’t work:
Tax cuts do not stimulate the economy by “putting money in people’s pockets” which they can then spend, as even some Republicans, including George Bush, mistakenly say. That’s an old-fashioned Keynesian strategy, and, if it worked, the same result could be achieved by sending out increased welfare checks, which also puts money in people’s pockets, which they can spend. But it doesn’t work, because it doesn’t do anything to change the basic incentives governing the economy, and because just borrowing money and then sending it out to people, in “tax rebate” checks or welfare checks, doesn’t add anything to the economy on net.
Tax cuts stimulate the economy when they involve reductions in tax rates. The reduction in rates improves incentives for savings, investment, business creation and expansion, job creation, entrepreneurship, and work, by allowing people to keep a greater percentage of the reward produced by these activities. This improves the economy not just by the dollar amount of the tax cut. The improved incentives affect every economic decision and every dollar in the entire economy. The astoundingly successful Reagan tax cuts in the 1980s, as well as the astoundingly successful Kennedy tax cuts of the 1960s, were both based on reducing tax rates, and were successful for these reasons.
It’s vital to understand that stimulus plans that do not cut tax rates simply move money from some hands to others. There’s no reason to expect that to have any particular economic effect. It might boost the economy, harm it, or leave it unchanged, depending on whether the recipients use the money more, less, or just as efficiently as the donors would have. On balance, the effects are likely to cancel out.
Cutting tax rates, in contrast, would be effective, because it would not merely move money around but change people’s incentives:
The Republicans should advance a proposal that would sharply reduce the 25% income tax rate that applies to the middle class to 15%. This would leave 90% of workers with a flat rate tax of 15%, or even less. Such reduced tax rates would provide real incentives to stimulate the economy, as discussed above. A bill providing for this should be introduced as soon as possible, to get the debate going. This proposal serves as an alternative to the rest of the Obama tax plan to be introduced later, as well as the stimulus package. Senate Minority Leader Mitch McConnell raised precisely this proposal last Sunday. Bravo.
Other proposals would promote economic recovery and growth even more. Most urgent, in terms of producing the biggest and most immediate pro-growth impact, is to reduce the outdated and uncompetitive federal corporate tax rate of 35% at least to 25%, if not the 19% recently adopted by Germany and Canada. The Bush tax cuts for capital gains and dividends should be made permanent. Also urgent would be to adopt immediate expensing, meaning deductions, for investment in capital equipment, rather than depreciation, which drags the deductions out over many years. This would have the same effect as a rate reduction for investors, by increasing the percentage of the reward that such investors could keep. A true economic boom would be created if Congress also reduced the top marginal income tax rate to 25%.