Wednesday, February 4, 2009

Tax Cuts as Kabuki Theater

President Obama, seeking a "post-partisan" consensus on a massive stimulus package, has played well his role in the plot-setting first act of the latest in Kabuki theater, Washington-style. Wanting a stimulus for an increasingly sick economy, a few first steps on climate change, and a down payment on a new energy policy, he now struggles to entice 80 yea votes in the Senate by offering tax cuts in an effort to placate Republicans. He shouldn't bother--it's bad policy and bad politics both. Kabuki's second act is typically a battle, and true to style, the US House showed no bipartisanship whatsoever. Sen. Charles Schumer is right about courting GOP votes:
The more the better, but I will say this. I'd rather have a really good bill that helps our economy get out of this mess, with 65 votes, than dilute the bill and get 80 votes.
He's right. Compromises for political expediency can be costly in more than mere political terms.

Republicans never saw a tax cut they didn't like, but realty-based lawmaking demands a different approach. Bob Borosage of the Campaign for America's Future cuts to the chase:

Tax cuts come in a distant second to public investment in actually creating jobs.
The effect of tax cuts is anemic compared to other forms of stimulus, particularly government spending. According to Mark Zandi, Chief Economist at Moody's, Inc., who directs’s research and consulting activities, "the goal of a fiscal stimulus plan is to maximize the near-term boost to economic growth without weakening the economy’s longer-term prospects." Although his analysis [pdf] is from last year and focuses on a then-large $150B proposed plan, the core points remain valid:
Tax incentives to stimulate business investment ... [are] not a particularly effective way to boost near-term economic activity, but it will make any plan more politically palatable and thus smooth its quick passage.

The economic bang-for-the-buck of bonus depreciation is very modest. Indeed, of all the tax and spending policies considered, it provides the least amount of stimulus.

Making the current dividend income and capital gains tax rates permanent would also make for poor economic stimulus.

Making [the Bush tax cuts] permanent would provide very little economic stimulus at this point. Some households would spend more freely given the certainty of their lower future tax rates, but most do not have the financial resources to do so.
This is the folly at the heart of the ceaseless blather about tax cuts as the solution to all our ills. Such an artifice doesn't actually put money in the pockets of very many people who would actually spend it on goods and services, the critical outcome for any policy to be stimulative. Of all the approaches analyzed, the least efficacious by far are permanent tax cuts, of any kind--personal, corporate, dividends, or capital gains. Along with accelerated depreciation (another form of business tax reduction) each of these stimuli is less than half as effective as anything else, as measured by the number of dollars in GDP growth per dollar of stimulus (whether tax cut or spending.) Put another way, anything but these tax cuts would be more than twice as effective; some, such as infrastructure spending is more than three times more effective.

Keynesian stimulus not only works, it works better than tax cuts. So why the perseveration on tax cuts? Simple: politics instead of basic economics [emphasis added]:

Hale "Bonddad" Stewart explains why we need a stimulus, and in turn explains what "stimulus" means. It's been successfully framed by the right as a tax cut and nothing else, but that's completely bogus, so it's important to break down what's happened to the economy and why extraordinary measures must be taken...

The equation for GDP (Gross Domestic Product) is Consumer spending (C) + Investment (I) + Net Exports (E) + Government Spending (G) = GDP. We've already covered personal consumption. It's dropping hard and fast... As for total private domestic investment, consider the following percentage changes from the preceding quarter starting in the 4th quarter of 2007: (-)11.9%, (-)5.8%, (-)11.5%, 0.4%, (-)12.3%. Because the US is a net importer the exports part of the equation is moot. That means the only thing holding up the US economy is government spending. And considering the mammoth drops in investment and consumer spending in the latest report (-12.3% and -3.5%, respectively) neither of these numbers appears ready to turnaround anytime soon.

There are some Republicans who are arguing that tax cuts are the answer. But there are several problems with that. The first is tax cuts were advertised as an engine of job creation in 2003 and we got one of the lowest rates of job creation on record [...] In addition, recent history demonstrates that tax cuts will go to savings and paying down debt rather than consumption. In addition, there is little reason for business to invest in production right now. That leaves pure spending [...] There's an old maxim in business: you've got to spend money to make money. That's where we are now as a country. We've exhausted the possibilities of the buy everything you can on the planet school of economic thought. We're in debt up to our eyeballs -- we are in fact choking on all of the debt we have wrapped up in consumption. We need to change models. That means we need to invest in new technologies and improve our basic infrastructure to attract and support this new business. It's really that

Let me add one other tangible way to prove that government spending is all that's left: the buildup of unused goods in warehouses and stock rooms.

Consumers didn't consume, businesses didn't invest, overseas buyers of American goods didn't buy and unsold products piled up in warehouses in the final months of last year. Those factors combined to drive the economy to its weakest quarter in nearly three decades and signaled that the worst is still to come.

New government data showing that the economy contracted at a 3.8 percent annual rate in the fourth quarter was not as grim as economists had forecast. But the data on gross domestic product, released yesterday by the Commerce Department, were a portrait of an economy in a deep and broadening recession. Business inventories swelled as consumer appetites waned, suggesting that companies will cut their excess stockpiles and curtail new orders this year, pulling down growth in the months ahead.

There's no consumption, no investment, and no trade. Lump-sum payments to consumers will pay down debt and do nothing for the economy. Government spending is the only answer. This is not being done to fulfill a Democratic wish list, it's being done because we have no choice.
Even as utterly discredited arguments are continuously recycled in favor of feckless tax cuts, specious ones are employed to discredit other approaches. The arguments pick at minuscule bits of the proposed overall stimulus package. Epitomizing these deeply unserious objections are the Republican's list of the 32 most wasteful provisions. Two of these 32 are emblematic of a failure by the GOP (Generally Obstructing Party) not only to appreciate basic economics of stimulus, but also the resistance to realistically respond to the crying need to restructure our energy economy:

Look at what the GOP considers to be pork in this bill:

The biggest line item is $6 billion for greening federal buildings. This is stimulus at its best. Thousands of labor-intensive American jobs. Hundreds of millions in new orders to American manufacturers for windows and weather stripping and caulk and insulation. And it has the added bonus of saving taxpayers millions down the line: You reap long term savings in energy costs and have the added bonus of reduced greenhouse emissions.

[Another line item is] $850 [million] for Amtrak. Verdict: Stimulus, as sure as federal highway spending is stimulus.

If this is the best the GOP can offer to justify its obstructionism, then the objective is clearly not about saving money. It’s about forcing a popular president to expend political capital.

The third act of Kabuki usually culminates "in a great moment of drama or tragedy" and is often followed by another battle in the fourth act before a "quick and satisfying conclusion" is reached in the concluding fifth act. Most observers expect some kind of stimulus bill to pass and be signed by the President, with or without Republican support. This will likely entail both great drama and some measure of tragedy, depending entirely, to the detriment of the country, on purely political considerations.

Certainly, this stimulus act will not be the last any more than the greatest theft of US taxpayer money, the TARP, was. There will be a fourth act, another, even larger package under even more desperate circumstances, and closer to the next election for which the players are already positioning themselves. President Obama understands that it will take more than one (or maybe even two) presidential terms to achieve the critical goals of restructuring our energy economy and repairing the environmental damage and neglect long unaddressed.

GOP Senate Minority Leader Mitch McConnell echoes Mark Zandi in part when he says of the stimulus that it be "timely, temporary, and targeted."

The targeted part is clear to all but the GOP: forget tax cuts and focus on spending, particularly where it creates something of enduring value to the country and its people: infrastructure such as a better electrical grid, expanded rail and public transit, and a modern communications infrastructure of broadband and wireless, where we, shockingly, trail many of our economic peers and competitors.

The timely part is tough; the stimulus was needed yesterday and there are (we are told) not enough "shovel-ready" projects on which to spend that create jobs quickly. There are ways, I believe, to create immediate job and economic impacts, but lawmakers are not looking in the right places, for reasons that are both interesting and profoundly troubling. (More on that in a future post.)

The temporary bit is simply wrong. If this were just another seen-it-before typical recession then, sure, any stimulus needs to be brief so as not to ignite inflation as the economy expands. But this is anything but a typical recession for a host of reasons as is becoming clearer every day. With the potential for a years-long period as housing, consumer credit and commercial real estate deflate, with the imminence of peak resource effects (oil, uranium, phosphorus, water, fish, others...) and with the urgent need to rebuild and rethink our entire approach to energy and consumption, this is different. It may not be another Great Depression (whatever that means) but it is different, very different, from what has come before. Writes James Galbraith in his article, "Stimulus Is for Suckers: We Need a Recovery Plan that Will Last for Years":

The historical role of a stimulus is to kick things off, to grease the wheels of credit, to get things "moving again." But the effect ends when the stimulus does, when the sugar shock wears off. Compulsive budget balancers who prescribe a 'targeted and temporary' policy, followed by long-term cuts to entitlements, don't understand the patient. This is a chronic illness. Swift action is definitely needed. But we also need recovery policies that will continue for years.
We could be in for a very long fourth act.

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