Tax cuts, not government spending, are the best way out of recession

During a financial crisis, it is important to create incentives for working toward economic recovery. Since normal situations of high taxation already “discourage work effort, saving, and investment, and promote tax avoidance and tax evasion,”[[http://www.house.gov/jec/fiscal/tx-grwth/reagtxct/reagtxct.htm]] this can only be amplified in situations where people feel especially stretched thin during economic distress. Government coffers become stretched by the added burden of spending, and with economic downturn there is less revenue generated. This lack of government revenue is further aggravated by when workers are forced to adopt behaviors to avoid paying taxes (such as taking jobs that pay under the table and never report their income). This is counterproductive toward the aim of recovering the economy. This forces either deficit spending in order to cover the cost of whatever the government spending might be, or government spending being insufficient to cover the costs of its intended purpose. It lacks a guarantee that the government can afford to continue the spending it promises.

Taking a lower amount of taxes on a percentage basis is a short-term mechanism to stimulate economic growth that translates into higher taxes in the long term when there is more money overall to be taxed. President Reagan cut taxes during the 1980s in the United States, and all projections were assumed for revenue shortfalls, or if nothing else, no increases in overall taxation revenues. However, the taxation revenue on individual incomes increased from 1980 to 1989, nearly doubling, from $244 billion $446 billion. Similar measures from the 1920s and 1960s also showed growth in overall taxation revenues after their implementation rather than expected shortages.[[http://www.house.gov/jec/fiscal/tx-grwth/reagtxct/reagtxct.htm]]

In fact, when recession hit the United States in 1919, a series of tax cuts over the next nine years kept the economy stable, and the recession itself was over within two years. It was only after government spending increased in the 1930s in response to the 1929 Stock Market Crash that the economy plummeted into the true depths of its depression[[http://www.ibdeditorials.com/IBDArticles.aspx?id=334276867815560]]. Since it has been established that status quo taxation will provide incentives for citizens to subvert the legal norms of taxation payments, the reduction in taxation engenders loyalty between citizens their governments, and influences enough growth to more than pay for itself in a short time after implementation has occurred.

The government has no incentive or barometer for efficient allocation of resources. Rather than searching out arenas for profit growth, the government seeks to do damage control. Since the government does not seek profit, it has no way of telling how efficient it is in allocating resources. Unlike firms, the government cannot be allowed to fail, meaning there is no penalty for inefficiency and no competitive alternatives. Most importantly, the government is funding existing firms or projects, which are being funded because they have already failed or are on the brink of failure.

We often see government expenditure touted as the fastest way to improve GDP growth. With “each dollar of government spending” the GDP “increases…by only 1.4 dollars”.[[http://www.economics.harvard.edu/files/faculty/40_Is%20Govt%20Spending%20Too%20Easy.pdf]] The increase for endogenous tax cuts (i.e. tax cuts attempting to help a faltering economy) are estimated to show about 3 to 1 growth in GDP.[[http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf]] Government spending and taxes are not separate issues. Governments can only pay off expenditures with tax hikes. The Romer study suggests that “an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent”, a phenomenon likely caused by the fact that “investment falls sharply in response to exogenous tax increases”.[[http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf]] What seems like a way out of recession may actually be a step into another one.

A recent example would be JP Morgan Chase Bank’s 25 billion dollar bailout: a bailout they used to finance their own private acquisitions, not to make loans. They issued a statement that read “loan volume will continue to go down as we continue to tighten credit”. JP Morgan took 25 billion but did not provide much-needed loans to small businesses, employers, and individuals which would have helped, among other things, to create jobs and improve the housing market. If JP Morgan felt they could make a profit from giving loans, they would. But all of their returns are heavily taxed to the point that making acquisitions is a safer and more profitable short-term goal, even though it does not improve the economy a bit.

Tax cuts are more efficient because firms following their self-interest will seek investments that provide profit. With heavy corporate taxes, firms are forced to either take on too much risk to make profit which can lead to financial collapse, or they merely make safe moves and firms that make acquisitions profit more than those taking risk. This is less than desirable because too cautious or sparse of investment means that there is likely to be little growth. Additionally, the corporations that are able to acquisition are the larger which means an economy may see oligopolies and eventually monopolies form which will harm the competitiveness of the market.

In addition, tax cuts are preferable because the forces of supply and demand can more freely work on their own. Firms seeking profit are more sensitive to demand than governments seeking to employ and prop up. Thus they affect supply so that the market is cleared as supply and demand meet and wastefulness is minimized. This makes for a more efficient allocation of resources and a much more sustainable economy. Both are necessary to recover from a recession.

An increase in jobs is a fundamental part of getting out of a recession. Consumer spending needs to be increased in order to see tangible growth in the economy and consumer spending can not be increased as long as consumers remain unemployed. The most efficient way to create jobs is to decrease corporate taxes that create incentives to create new jobs. For example, the state of Michigan enacted policy that substantially decreased corporate taxes on companies that created new jobs in high-growth sectors such as green and bio technology.[[www.michigan.gov/documents/gov/Econ_job_223200_7.pdf]] The purpose of business is to profit and through corporate tax cuts, business will have the ability to profit easier while creating jobs. Employed consumers spend the necessary money to stimulate and grow the economy. This is proven in the example of Ireland, which adopted a 12.5% corporate tax in 1988 while having the second-lowest per capita income in Europe and now has the second-highest income in Europe.[[http://www.forbes.com/2009/02/04/tax-cut-stimulus-opinions-contributors_0204_peter_ferrara.html]]
Recently, the French government posted figures of 0.3% growth in GDP for the second quarter of 2009, an indicator it is coming out of the recession. Across the euro zone, only Germany matched this growth. This was unexpected by experts and while it does not mean the recession is over for France, it is encouraging. One of the key forces behind this was an increase in consumption. Consumption increased by 0.3% this quarter. This increase was the aim of the government when reducing VAT as part of its strategy to combat the recession. For companies such as restaurants and cafes, VAT was slashed from 19% to 5.5%, which industry bodies predicted successfully would lead to an increase in consumption.

[[http://www.dw-world.de/dw/article/0,,4446507,00.html]]
[[http://www.google.com/hostednews/ukpress/article/ALeqM5jXJawG8lN9DDRVZ8N5-VSsc4_-Dw]]

Government spending can also create jobs but the question is are these jobs suitable for getting out of a recession? The answer is a resounding no. Let’s examine one of the largest attempts by government to create jobs, Roosevelt’s Public Works Administration which allocated $3.3 billion dollars for public jobs to stimulate employment[[http://www.nps.gov/archive/elro/glossary/pwa.htm]]. The jobs created by it usually lasted only months allowing only short term employment and the unemployment rate remained above 9%[[http://www.opinionjournal.com/editorial/feature.html?id=110011064
]]. Many of the jobs consisted of building public structures and murals such as a mountain theater that were not done to grow the economy further but to grow political capital. After the expenditures stopped, so did the jobs.

Only private industry can provide the long term stability and job creation through new and improved investments which are vital economic necessities to get out of a recession. By providing corporate tax cuts to incentive this, governments will not fall in a pit of spending that only provides sparks and stifling the private industry that could make blazing positive changes in the economy.

When trying to recover from a recession it is vital that the government encourages saving and helps provide the means through tax cuts. Savings is important because it so often takes the form of investment in the market. By the laws of supply and demand, the more investment that enters the system, the less companies need to pay to borrow. Thus it is easier for these companies to employ and expand. With tax cuts pocketed, households will be more likely to save or invest their money in greater-growth opportunities. Since tax cuts provide for a multitude of investors, the rate of failed investments will be much lower than if the government makes huge lump sum expenditures in large investments.

Also, tax cuts for individuals can help households better handle temporary reduction in hours they are experiencing at the time or anticipate to experience in the near future. The less the government takes from households the more income there is to go towards balancing a recession affected budget. When a household runs a deficit it is nearly impossible for that household to increase consumption as the economy will need in order to recover.

Simplicity should be the cornerstone of any monetary policy because simplicity brings predictability to consumers and companies. When both groups know what to expect, they will be more apt to act.[[http://online.wsj.com/article/SB122757149157954723.html]] According to Milton Friedman’s permanent-income theory, consumers spend not in regard to their current income but what they expect their income to be in the long term. Tax cuts offers a consistent and predictable principle that restores consumer confidence that is needed to get out of a recession because they know if and when they can act on a expected long term income.

Government spending, on the other hand, seems to be allergic to simplicity. It is rather inconsistent, for example the bailout of Bear-Sterns and not Lehman Brothers[[http://economistsview.typepad.com/economistsview/2009/03/failing-to-bailout-lehman-brothers-was-a-mistake.html]] or the substantial lack of transparency in the Troubled Asset Relief Program (TARP)[[http://blog.sunlightfoundation.com/2009/07/20/they-dont-call-it-tarp-for-nothing/]]. The complexities and variances of government spending leave consumers in a world of uncertainty and lead to declines in consumer spending and investment.

While the causes of recessions may be highly complex, governments need to provide simple and elegant solutions that consumers can understand and adapt to. Government cannot rely on solutions cloaked in complexity that even government officials don’t understand and cannot explain to their constituents.[[http://www.nytimes.com/2009/02/10/business/economy/10bank.html
]]

Protectionism is bad for the world economy, and in a globalized world, bad for all economies, particularly third world economies who are unable to sustain themselves on their domestic markets. When the U.S. passed the Smoot-Hawley Tariff Act (which the U.S. Gov’t self-admittedly calls the “high-water mark of U.S. protectionism in the 20th century”[[http://future.state.gov/when/timeline/1921_timeline/smoot_tariff.html]]), France, Britain, Germany, and Canada reacted with protectionist or reductionist policies of their own which many economists agree lengthened and strengthened the severity of the depression. The recent government expenditures have led to protectionist policies that reduce total global revenue and lengthen the recession, an outcome that could be avoided if tax cuts were adopted instead.

“National policies employed by the UK, French, Dutch and Austrian governments to build up liquidity reserves at home [are] creating a protectionist environment…[which has] adverse side-effects on the fabric of the globalised financial system [that] are already visible and, if left untended, will become more serious”.[[http://www.telegraph.co.uk/finance/economics/5505726/Government-lending-targets-for-bail-out-banks-feed-protectionism-warns-IIF.html]] When governments subsidize their own industries and firms, other countries must in turn subsidize theirs, devalue their currency, or tack on tariffs to remain competitive in the global market. The WTO[[http://www.newsweek.com/id/175062]] and IMF have expressed concern about the future of the global trade markets. Tax cuts provide incentive to look for markets outside of the domestic exchange, increasing global revenue and creating job opportunities and capital investment opportunities that are not always possible domestically.

Tax cuts are the best strategy for getting out of a recession. Based upon the evidence we have brought forward, we see that government spending has long-term negative effects that hurt workers and the world economy. Tax cuts help workers, capitalists, and the overall economy.