Friday, September 10, 2010

Tax Contradictions -

Review & Outlook: Tax Contradictions -


After 20 months and more than $1 trillion down the Keynesian drain, President Obama is discovering the virtue of tax cuts.

Yesterday the President proposed a $180 billion plan that includes a permanent research and development tax credit and a tax write-off for all business capital purchases in 2011. These are both sensible ideas that would counteract at least some of the damage from Mr. Obama's looming tax increase. John McCain could sue for plagiarism because versions of both ideas were part of his 2008 campaign platform.

The White House will deny it, but it's important to understand what a conceptual switcheroo this is. Mr. Obama's economic policies to date have been based on the belief that government can drive growth by handing out checks to consumers, who will then spend the money and increase what economists call aggregate demand. Missing was any attempt to spur incentives for business or individuals to invest and take more risks. Even if this policy reversal is motivated by election desperation, it is still a tacit admission of the failure of its growth model.

The big flaw in this proposal is that it's temporary. If the tax cut is for only one year, businesses will move spending forward that would have happened in future years. The economy will grow faster in 2011, other things being equal, but some of that growth will be stolen from 2012 and 2013. We've seen this temporary effect before with the home-buying tax credit, cash for clunkers and tax rebates.

In the Keynesian world-view, this is no problem because the one-year policy is supposed to kick-start the recovery and the stimulus can be safely withdrawn because the economy will become self-sustaining. But in the real world, investment will be greater and growth will be faster with a permanent reduction in the tax penalty on capital that will permanently increase the value of that capital. The White House still has some tax learning to do.

We'll nonetheless give the President and his economic team points for intellectual progress. Their proposals for corporate tax cuts are a de facto recognition that the 35% U.S. corporate tax rate is too high.  Now that Mr. Obama has conceded that tax cuts are good policy, Republicans should see him—and raise.




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