Sunday, November 22, 2009

How Stimulating. . .

Let’s continue our rebuilding the Republican Party series by explaining how stimulus plans should be done. With GDP crashing, unemployment soaring, and a double dip recession knocking on the door, it’s time for the Republicans to suggest a plan to stimulate the economy. Not more spending, as Obama proposes, but a genuine stimulus plan. Here it is. . .

About a week ago, we explained why conventional stimulus plans never work, and why Obama’s was worse that most. We noted that most stimulus plans try to increase demand, either by getting consumers to spend more money or by having government spending replace falling consumer spending. But this is problematic.

Getting consumers to spend more simply shifts economic activity from the future to the present. This can stimulate the economy now, but it depresses the economy in the future. Government “stimulus spending” is even worse, because the money the government spends must first be taken from consumers. Thus, the government depresses the economy at the same time it tries to stimulate it. . . unless the government borrows the money, in which event it depresses the future.

Just thinking about this logically should be enough to give us pause. If stimulus spending really could increase the overall economic activity of a country, wouldn’t it make sense to start spending wildly and to keep spending until we were all rich. Yet, even the most wild-eyed proponents of stimulus spending don’t think that’s a good idea.

Moreover, by directing spending (e.g. cash for congressmen. . . er, clunkers), the government creates distortions in the market, where money is spent on projects that are less beneficial to society than those upon which the money would otherwise have been spent. This causes the economy to be less efficient and can lead to significant problems down the road (like housing bubbles).

The goal of a stimulus plan should be to encourage people to generate more wealth. More wealth means a greater capacity to spend without stealing from the future. Stimulus spending does not do that, it only shifts money around from savers to spenders or from the future to the present. So what would do this? Here are two proposals:

Proposal 1: Cut The Payroll Tax
Our first proposal is to cut the payroll tax. Why? Because that will encourage people to work more and it will encourage employers to hire more.

Human beings value leisure. It’s true. When the value of working exceeds the value of leisure, they will work. When it does not, they goof off. Want proof?

Ok, would you come work in the Commentarama file room on Sunday for one hour for free? Probably not. Why? Because you value your leisure time more than you value what you would get from working for us. . . a big old goose egg. But what if I offered a crisp fiver? Still nothing? Ok, what if I offered $500. Suddenly, you’re starting to think about it. Some of you will accept this, some won’t. If I offer $1,000, more of you will jump at the offer. At some point, each of you will jump. . . like lemmings. The point where you would jump is the value that you place on one hour of leisure.

To get you to work more, our stimulus plan needs to increase the value of working to the point that it exceeds the value you place on your leisure time. Fortunately, people don’t value all of their leisure hours at the same rate. Indeed, it takes a lot less to get someone to agree to work 41 hours instead of 40, than it does to get them to agree to work 70 hours instead of 40. So even minor changes to the value of work can get people wanting to work more.

The easiest way to increase the value of working is to cut the payroll tax. By decreasing the amount the government takes from your paycheck, the government makes each hour of work more profitable. This gives you an incentive to convert some of your leisure time into work time. As millions work more, they generate vast amounts of economic activity. They can then turn the extra money they earn into spending, i.e. stimulus, without the normal negative effects of stimulus spending because they generated that new wealth rather than merely shifting it from the future to the present. Basically, cutting the payroll tax encourages people to convert their leisure time into stuff.

But will the work they seek be available? Yes, especially if you cut the employer contribution as well. Cutting the payroll tax decreases the cost to the employer of employing you. Think about a company that employs 50 people at $20,000 per year each. That company has a payroll of one million dollars per year. A two percent reduction in the employer portion of the payroll tax results in cost savings to the company of $20,000 a year. That means the company can hand out more overtime, increase salaries, or hire one new employee without any increase in overall payroll costs.

This effect will be repeated across the economy as a whole (because all workers are affected by the payroll tax), leading to increased incomes and increased employment opportunities. And, best of all, nothing is stolen from the future to make this happen.

Interestingly, several European governments have experimented with this and found it to be highly effective in reducing unemployment. I have also see estimates that a 1% cut in payroll taxes would generate three million new jobs.
Proposal 2: Decrease The Capital Gains Tax
Wait, don’t hit that mouse button. I can explain this in a way that makes sense and that won’t have you trying to slice your wrists. Here’s why a capital gains tax rate cut will spur economic activity.

First, I’m not talking about stock sales when I say capital gains. What I’m talking about here are the gains that companies experience when they sell capital equipment, like bulldozers or computers. What gains you ask? Well, when you buy something like a bulldozer, each year you write off a portion of its value as depreciation. If you then sell it for more than the value at which it sits on your books, you have a gain. . . a capital gain.

If we reduce the capital gains tax, we will increase the incentive for companies to replace their capital equipment sooner. That means more jobs for the makers of the equipment, as more people are needed to make those computers or bulldozers.

With more companies trading up sooner, this also means that there will be more (better/newer) equipment available in the "used equipment" market. This will help smaller companies who can’t afford to buy new equipment. These companies can then replace their own bulldozers/computers and pass what they have into the used market quickly as well, which helps someone else down the line. This improves the efficiency of each of these companies, which usually means more money to expand.

The same effects will occur in any capital equipment market.

Interestingly, the Democrats hate this idea. This shows their inability to give up on class warfare. A capital gains cut generates jobs and stimulates the economy, there is little serious debate about that. BUT, it also benefits people with money, and that is intolerable to the left. They would rather that no one benefit, than run the risk that a rich person might benefit more than a poor person.

So far, the Republicans have been unable to explain to the public why the Democrats are wrong. Part of it lies in an inability to explain why this tax cut works. For example, it was obvious that McCain didn’t have a clue when the issue arose in the debates. But equally importantly, the Republicans usually focus on a generic capital gains cut, which includes the profits from the sale of stock. This allows the Democrats to paint this as a plan to let a thousand Scrooge McDucks sell their stock and use the gains to buy more gold for their money piles. To counter this, the Republicans should propose limiting the capital gains tax cut solely to the sale of capital equipment (or eliminating the capital gains on the recapture of depreciation). This would allow the Republicans to paint the Democrats as opposed to workers.


Cutting the payroll tax and the capital gains tax would truly stimulate the jobs market, would stimulate people to work more, and would result in overall increased economic activity. The effect from both would be immediate, so there’s no need to wait for the spending to kick in, and neither suffers from the problem of stealing from the future. With the economy in such a poor state today, and Obama out of answers, now is the time for the Republicans to put forward this plan.


Tennessee Jed said...

Those are both proven methods to achieve stimulating the job market, no doubt about it. Rather than have government take over industry, government needs to make the economic climate as easy as possible for private enterprise to flourish (the business of the nation is business!)

Writer X said...

Unless the words "tax increase" and "new government program" are in the plan, I can't think of a single Democrat who would be in favor. Conversely, the Republicans really do a poor job of articulating economic ideas that work, even though the ideas are logical.

AndrewPrice said...

Writer X, You're right. The Dems won't support this because (1) they don't understand how it improves the economy and (2) they don't want to do anything that helps the evil rich.

And you're right about the Republicans. Whenever they start talking about economics, they sound like accountants explaining the intricacies of the tax code. They need to learn to put these things into regular English.

AndrewPrice said...

Jed, The best part about these, besides the fact that they actually work, is that they don't distort the market like government interference. These methods get people to work more, not just spend more or spend differently.

LawHawkSF said...

Andrew: The ability of the Democrats to explain their crazy schemes and make them sound good is that they have no idea how economics work in the first place, and they know which buzzwords to spout to accomplish their destructive goals. And you are so right about the Republicans. Many truly seem to understand the underlying financial solutions, but come off sounding like robot accountants when they try to explain it. And until conservatives learn how to explain basic market concepts, we're going to continue to lose to the "what's in it for me?" leftist quick-fixes.

AndrewPrice said...

You've put your finger right on the problem Lawhawk. The democrats know enough buzzwords that people think their plans sound good, even though they are utterly insane. And of course, they've always got a team of economists ready to back up whatever insane plan it is and declare it a great plan.

At the same time, the Republicans always come across like accountants. If they could learn to put their ideas in normal English and drop the caveats and technical terms, they could do so much better!

MegaTroll said...

Great ideas. I wonder if Obama will consider these ideas at his jobs conference? Do you think the Republicans will propose this?

AndrewPrice said...

Mega, The Republicans have made proposals like this, but the media hasn't covered it. I think they need to make a big deal of creating their stimulus package -- this -- and then introducing it now, while Obama/Biden are claiming that the recession is over. That lets them argue later that they could have prevented the harm the recession does.

StanH said...

All good ideas Andrew, and would indeed stimulate the economy. With Washington politicians it’s about the power, most especially the Marxist. Review the bidding, we have: C. Dodd, Barney Frank, Harry Reid, Nancy Pelosi, Barry Obozo, Joe BBBB…Biden, in charge of taxes, regulation, etc. We have a better chance of these clowns to start preaching personal responsibility as we do to have them lower taxes. Since we’re pissing in the wind; I like a more radical approach abolish the IRS and replace it with the “Fair Tax,” this is not a VAT Tax! You’d have to repeal the 16th Amendment, and so on, etc. Business would explode in this country, most industry would return. My favorite part is it would defang the Federal Government, even though at a fixed 23% it would be revenue neutral, they’ll never go for it right or left, because they lose the power. I love what you’re saying Andrew, and it would work, it’s far to sensible for our current ruling class…yuk!

AndrewPrice said...

Stan, We'll see desperate times (pre-reelection) bring desperate measures.

wahsatchmo said...

Specifically, you could implement the reduction in taxes on the sale of tangible personal property used in a business (Sec. 1231 property in the Internal Revenue Code) by getting rid of depreciation recapture (Sec. 1245 and Sec. 1250) as well as Sec. 179 recapture. Any time equipment is sold, the amount of the gain on the sale up to the extent of accumulated depreciation is taxed at ordinary tax rates (or at a high flat rate under Sec. 1250), which are higher than normal capital gain rates. C corporations don't even benefit from capital gain rates on the sale of any capital property, including the sale of non depreciable capital property. Why not extend capital gain tax rates to C corporations as well?

AndrewPrice said...

Wahsatchmo, I haven't gone into specifics of implementation because that's a little beyond the broad sorts of policies we are talking about here.

That said, I agree with your points (though I admit my knowledge of C corp tax is a little limited). Those two changes should be very beneficial to small businesses, which is where most jobs are created.

wahsatchmo said...

Yeah, I mainly wanted to show off my knowledge of the tax code to impress the ladies.

But I like the idea of repealing the effect of Sec. 1245 and 1250 as opposed to any more Sec. 168(k) stuff, of which GWB was so fond. That basically allowed businesses to write off up to 50% of new personal property in the year of acquisition, but it still left recapture in place.

168(k) did stimulate some investment, but it effectively taxed any sale of that equipment at ordinary rates. I like your idea of taxing that sale at lower capital gain rates, which could be achieved by addressing just sections 1245 and 1250. No new capital gain rates required.

AndrewPrice said...

Whasatchmo, LOL! I'm sure they're impressed!

Thanks, I think it's a good idea both economically as well as politically because it's much harder to attack a policy that would get people to sell their used equipment quicker than it would be to attack a policy that could be painted as relating mostly to stocks.

You're right about the reduction in the write-off. It sounds good in principle, but if the write off can be recaptured, the stimulus effect is kind of light.

Thanks for the comments!

WillORNG said...

The US has a lot to learn from Europe about tax revenue raising efficiency.

Yes cut income taxes, cut distorting 'reliefs' these are spending and government economic behaviour distorting. But there should be higher property taxes and VAT/Sales as these dont distort productive behaviour and encourage good old fashioned conservative saving as opposed to Republicrat spenders like Bush and Johnson.

It's not the greatest way to deal with demand loss though.

Meddling with technical CGT arcana is borrowing from the future artificially and as 'bad' as cash for its dry arcane accountant speak, to boot!

Oh, and tax alcohol, tobacco and social drugs heavily too, it's regressive but sure cuts those non-fiscally conservative deficits!

AndrewPrice said...

Will, Our tax system is horrible, not only does it cause massive distortions all over the place, but it's designed to let politicians hand out favors by tickering. And it's virtually impossible to understand. But there is no will (or widespread public desire) to change the system significantly.

Despite our problems, I would not want to adopt the European models. The problem with the VAT tax is that it's a hidden tax that can be raised without anyone realizing it. I would rather have a sales tax than a VAT tax.

But the idea of shifting to a sales tax (or any sort of consumption tax) has limited appeal because the left in this country doesn't want any tax that hits poor people. They only want to tax "the rich."

In terms of alcohol and cigarettes, we do tax the heck out of those, and those taxes go up almost every budget cycle.

WillORNG said...

Andrew when our VAT rate goes back up from 15% to 17.5% everyone will know about it...and even more when the Tories put it up to 20%...

Property taxes are unpopular but technically an efficient and effective way of raising taxes.

AndrewPrice said...

WillORNG, You're right about property taxes.

On the VAT tax, my experience is with the German system (visiting relatives), where the tax is entirely hidden. So when the cost of the product shoots up, they don't know if it was the government raising taxes or if it was the company raising prices.

I don't know if it's the same in Britain or not?

We have a similar experience with the gas tax. Few states break out the cost at the pump. So when the price of gas increases, people blame the oil companies -- even though the price hike is often the result of the gas tax.

Also, my concern with the VAT is that "consumers" are a very hard group to organize in opposition to a tax increase because they are too diffuse. That makes it a very easy tax to hike.

I want an efficient tax, but I also want one that politicians can't raise easily.

If I was going to remake the tax system, I would probably look at a consumption tax or a property tax, but, sadly, I don't see much support in our country for any sort of major re-make of the system.

Thanks for the comments. You think the Tories will raise it to 20%? Ouch!

AndrewPrice said...

P.S. What I meant by "hidden" in the German system is that you see the one price and you pay it, there is no visible add-on that the customer pays that is specially marked "tax."

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