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Subject:  Stimulation and The Lack Thereof Date:  8/13/2004  10:14 PM
Author:  brucedoe Number:  8079 of 10593

One keeps hearing about how much stimulation to the economy the tax cuts are doing (these tax cuts are really long-term goververnment loans because they add to the Federal deficit). Actually, there is very little evidence of this. Such stimulation as there is, is from the Federal deficits and the low interest rates sparked by the Fed. Why is this the case?

Some time ago I tried to answer this. If you take the case of a revenue neutral tax cut (that is one in which Federal expenditures are decreased to balance a tax cut), the stimulation is decreased because most of the wealthy get most of the tax cut (they pay most of the taxes, remember.). But not all the increase in income the wealthy receive go into productive ventures. They will put a lot of their money into Treasuries (and foreign bonds) and existing stock which is not stimulative. This is not just an idea of mine but was expressed by Alan Greenspan and Paul O'Neill (then Treasury Secretary) when the so-called tax cuts of the Bush Administration were first considered. They will also do such things as buy Swiss chalets, islands in the Bahamas, and buy timeshares in Canadian Bombardier jets. None of these stimulate the U.S. economy though they may help the global economy. In contrast all of Federal spending is productive, even pork is productive to some part of the economy because the Federal government only contracts for services and items or gives money to people who spend it on something in the country ( rent, groceries, automobiles, etc.). In a revenue neutral tax cut, you therefore get less stimulation than if you had left things alone. One thing that you do get is a change in the mix of what money is spent on such as fewer battleships, highways, and low cost housing and more expensive mansions and other homes, more automobiles and home improvements, and, perhaps more groceries. An exception might possibly be a case where the Federal government is running a surplus and is paying down the Federal debt as in the last two years of the Clinton administration.

However, we did not do a revenue neutral tax cut, but added this money to a Federal deficit due to loss of revenue from the recession and the Afghanistan and Iraq wars. Therefore we had the stimulation of the increased Federal deficit plus the exceptionally low interest rates fostered by the Federal reserve. And the high demand for Treasuries as a result of the so-called tax cut lowered the long-term Treasury rates.

A New York Times editorial on August 12 (Painting the Economy Into a Corner) states that the reduction in tax rates provided only 59 cents on the dollar of economic stimulous whereas the tax cuts for dividends and capital gains produced only 9 cents of stimulous for every forgone dollar. "In contrast,the economic bang for a dollar of aid to state governments is $1.24. Yet such assistance accounted for only 3 percent of the total cost of Mr. Bush's fiscal policies." Unfortunately, the editorial does not give a souce for their figures, and, as a scientist, I am always suspicious of such numbers, especially in newspapers, but the trend agrees with the reasoning in the previous paragraph.

Now the worry is, why don't we have a roaring economy and raging inflation (of course, inflation is already rampant in propterty taxes, property insurance, dental costs, and health care insurance)? It seems that business fears that an improving economy is not clearly sustainable? I've noticed some on these boards who even still worry more about deflation than inflation.

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