My take on the US economy

Here are three common fallacies that I have heard recently:
1. Tax increases will always hurt growth, no matter if they are targeted-tax increases or not.
2. Cutting taxes will always stimulate economic growth, regardless of who benefits from the tax cuts.
3. Cutting taxes will eventually bring down the deficits as economic growth picks up.

The idea that cutting taxes will always stimulate private investment has not been proven. In fact, there is much evidence to the contrary. If rich people, like Romney, had 10 percent more money than they currently have, due to tax breaks, why would they be any more likely to build a new factory or to start a new business? They are not any more likely because there is a lack of demand for goods and services. And, they are sitting on their money waiting for demand to pick up. So, giving them more money will just increase the size of their bank accounts. It will not stimulate employment.

On the contrary, if rich people like Romney are NOT willing to build new factories or start new businesses, then it is the government’s role to increase their taxes so that they can redirect this money to creating new transportation projects and new research projects. The only way to get the economy unstuck is to increase demand for goods and services. And, the only way to increase demand for goods and services is to get people to spend more. The only way that people will spend more is if they have good jobs (e.g., a transportation job, a research job or an energy job). So, the key to growing our economy is either to run massive deficits as the government is investing in infrastructure or to increase taxes on the wealthy so that this money can be redirected toward investing in infrastructure.

In 2013, cutting taxes will only increase deficits. Cutting taxes will not stimulate economic growth, especially in the near term. Cutting taxes on the wealthy and even cutting taxes on the middle class will NOT result in the wealthy or the middle class spending more. Tax cuts will not foster increased spending, and tax cuts will not increase demand for goods and services. The way to get the middle class to spend more and thereby increase demand for goods and services is to get more people working. And, if the private sector is not willing to invest and to increase employment (due to lack of demand), then the government should stimulate hiring in education, in transportation, in energy, in research and development. The government has a role in stimulating demand, when demand is low. This is textbook macro economics.

So, the idea that all tax increases (even targeted tax increases on the super wealthy) will hurt the economy is just not true. Targeted tax increases can and will help to stimulate the economy–it enables the government to spend more on infrastructure investments without increasing the deficit. Moreover, the idea that tax cuts will always stimulate growth is not correct. Only by creating a stronger middle class and thereby increasing aggregate spending will we grow the economy.

By the way, I favor tax reform. In fact, I think that the U.S. needs to right the injustices of the Bush tax cuts. At the present time, rich people like Romney only pay 15 percent in taxes on millions of dollars in income ($21 million). Middle class America pays about 25% (17% income tax and 7.65% SS and Medicaid). Barack and Michelle Obama’s effective tax rate for 2011 was 20.5% on an adjusted gross income of $789,674. When one factors in sales taxes, property taxes and state taxes, the lower income people pay a significantly higher percentage of their income in taxes than do the wealthy. One source ( estimates that we pay about 50 percent of our income in taxes.

I would favor raising the maximum tax rate of capital gains to 25 percent. This would get the capital gains rate back to historical averages. Moreover, I would advocate returning to a more progressive tax system. I would advocate returning to 1970, when the top tax rate was limited to those making over $1 million per year rather than the current $379,000 per year. Moreover, during the Nixon administration, the top tax rate was 50 percent and the maximum capital gains tax rate was 32.3 percent. I think that a top income tax rate of 45 percent on those making $1 million per year and a 25 percent capital gains rate is fair. In fact, if the U.S. government allows the Bush tax cuts to expire, then we would return to a 25 percent maximum capital gains tax rate and 44.6 percent maximum income tax rate.

At this time, is it wise to raise taxes across the Board and return to the pre-Bush tax rates? Paul Krugman, the 2008 Nobel laureate in Economics, advocates higher deficits during this period of low interest rates. Krugman says that now is the time for the government to do massive investments in education, in transportation, in energy, in research and development. So, at this time, he does not advocate returning to the pre-Bush era tax rates. Rather, our focus should be on investing in infrastructure, on creating jobs and on building up the middle class, even if we have to run big deficits to do it. When the economy recovers from the financial crisis, then we should raise taxes and reduce government spending.

In short, I find that the pledge to never raise taxes to be ridiculous. Moreover, the idea that government does not have a role in stimulating demand during times of crisis is equally ridiculous. Finally, tax cuts do not always increase growth and neither do deficits magically disappear. Let’s move to a more fair tax system where the ones who benefit the most from living in the US should pay a higher percentage in taxes. Moreover, let’s never lose sight of the fact that a strong middle class is the engine that drives demand and fosters prosperity. And, by all means, when the middle class recovers from the current crisis, let’s radically reduce the deficit by reducing spending and raising taxes.

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