What’s the best way to boost economic growth – more government spending or lower taxes?
Government spending is the Keynesian approach, which was taken over the past eight years. Build a road, start a war or buy lots of bonds and the spending allegedly will stimulate the economy. In addition to the government jobs created, the money spent will work its way through the economy and create additional jobs while the economy grows.
But the economy doesn’t necessarily work that way. Government spending has to be paid for with higher taxes or more debt. If taxes are higher, consumers have less to spend, which slows economic growth. If the government accumulates more debt without raising taxes, interest on the principal accumulates. Interest must be paid off regularly to keep the country’s credit rating high, so it can continue borrowing at low rates.
Ironically, the only way to keep interest from becoming overwhelming is to cut spending, raise taxes or both, which can stunt economic growth. So, long term, the impact of stimulus spending can be negative.
Another problem with government stimulus programs is that jobs created with government funding disappear if and when the funding expires. It rarely does; instead it becomes an added cost on an ongoing basis, increasing government spending permanently.
How Money Is Spent Matters
How the government spends your money also matters. The American Recovery and Reinvestment Act of 2009, passed to overcome the financial crisis, was the largest stimulus effort ever, but much of the money went to programs that may have had either no positive economic impact or hampered economic recovery.
While Congress approved $787 billion in spending, the Congressional Budget Office now says that $836 billion was spent, including $99 billion to increase Medicaid spending, $64 billion on unemployment compensation and $48 billion on the Supplemental Nutrition Assistance Program (SNAP). Using federal funds to extend unemployment compensation resulted in people staying out of work longer – why look for work when the government is paying you to stay home?
Being the government, much of the money was also spent on politically favored projects; $4.3 billion went to build high-speed rail service between the California towns of Borden (so small, population figures are unavailable) and Corcoran (pop. 22,500) and $535 million was used for a loan guarantee for Solyndra, the now-bankrupt solar company. Hundreds of millions of dollars also went to wind farms that were built before the stimulus bill passed, weatherization projects, the Mohegan Sun casino and a Napa Valley wine train.
Some of the projects funded by stimulus spending were inefficient or potentially fraudulent; some benefited political donors.
Meanwhile, the Federal Reserve Board’s bond-buying program has ballooned the Fed’s portfolio to a value of more than $4 trillion and it’s unclear how the Fed is going to reduce its portfolio to a manageable size.
In spite of the American Recovery and Reinvestment Act, Fed bond buying and ongoing federal spending that caused the federal deficit to double to $20 trillion, the economy grew at a rate of just about 2 percent over the past eight years, well short of the 3.3% average since the end of World War II.
Granted, the stimulus program started after the worst economic crisis since the Great Depression, but the economic impact of the largest stimulus program in history has been underwhelming. See Japan and Europe for further results of the Keynesian approach.
The Supply Side Approach
Tax cuts and deregulation, which are favored by President Trump, are a supply side approach. Supply side economists believe the best way to achieve economic growth is through business investment and lowering of barriers on the production of goods and services. Lower taxes and fewer regulations make it less costly for businesses to expand and add jobs.
Another economic advantage of lower taxes is that when rates drop, taxpayers have less of an incentive to find loopholes and avoid paying taxes; so, ironically, when the government cuts taxes, it brings in additional tax revenue. The National Bureau of Economic Research found that each dollar of corporate taxes that’s cut returns 50 cents in new revenue, while each dollar of consumer taxes that’s cut returns 17 cents.
Proposed corporate tax cuts could be especially beneficial to economic growth. Currently, even though the U.S. has the highest corporate tax rate in the world at 35%, corporate tax receipts account for less than 10% of federal revenue, according to ZeroHedge.
One reason they account for such a small percentage of revenue is because of special deductions. Businesses can deduct operating expenses; employee-related expenses, such as health insurance; travel; insurance, and more.
Another reason is that a growing number of American companies have become un-American, purchasing foreign companies and moving their headquarters abroad. These “inversions” take place, because currently American companies with foreign operations are subject to double taxation. They’re taxed in the foreign countries in which they do business and again when they return revenue to the U.S.
“Attempts to punish companies that are pursuing corporate inversions misdiagnose the problem and, in so doing, make a bad situation worse,” according to a report from Pacific Research Institute. “The uncompetitive U.S. corporate income tax code is the root cause of the problem. The U.S. corporate income tax code imposes large economic costs on U.S. companies and dis-incents economic growth. Economic efficiency is best promoted when business decisions are based on economic fundamentals, not tax considerations. Unfortunately, the uncompetitive U.S. corporate income tax code ensures that this cannot be the case.”
President Trump is proposing to lower the corporate rate from 35% to just 15%, which would make it far less burdensome for companies to return money to the U.S. However, he’s also proposing the elimination of many corporate tax deductions.
“When you have a 15 percent corporate tax rate,” an administration official said, “we don’t believe that you have to give people a lot of deductions. And look — to pay for it you have to broaden the base. So you can’t go from 35 to 15 and still allow deductions. It’s just algebra.”
President Trump’s plan would cut individual tax rates as well, replacing the current seven brackets with brackets of 10%, 25% and 35%.
While The New York Times claims that the Trump plan would “significantly benefit the wealthy,” that would be true of any tax cut. As we’ve previously noted, the top 1% of American earners earned 19.04% of the country’s gross adjusted income, but pay 37.8% of income taxes.
And considering that half of the country doesn’t pay income taxes, the only tax proposal that would help low-income Americans would be one that gives them money.
The point of tax reform is to boost economic growth. We would all benefit from that, not just the wealthy.
Freedom vs. Government Handouts
Perhaps the biggest problem with government stimulus is that it gives the federal government more power and the average consumer less power.
Money in the hands of an American citizen can be spent freely wherever the owner wants to spend it. Money in the hands of the federal government is often spent inefficiently. The average American probably wouldn’t blow $4.3 billion on a rail line that serves two rural towns.
It comes down to a simple question: Should Americans be funded by government programs from birth to death or would you prefer a level of prosperity that enables almost all Americans to support themselves?