Obama's "American Jobs Act" Fudge

President Obama’s so-called “American Jobs Act” consists of $447 billion in tax cuts and spending increases meant to stimulate job creation and economic growth.

More than half of the proposal, at $240 billion, is allocated towards cutting the payroll tax. The employee side of the payroll tax is cut by 3.1% for a total cost of $175 billion; while the employer side of the payroll tax is cut by 3.1% for the first $5 million of payroll and by 6.2% for new hires and pay raises for current employees, all at a cost of $70 billion.

The next largest provision of President Obama’s proposal is spending $140 billion on public work projects and state aid. This consists of $50 billion to be spent on highway infrastructure and public transportation, $35 billion to subsidize teacher and first responder employment by state and local governments, $30 billion to state and local governments in order to “modernize” schools, $15 billion towards repurposing vacant property (basically, an urban renewal program), and $10 billion towards an “Infrastructure Bank” which would leverage private funds for public work programs.

In addition to all of the above, President Obama’s proposal allocated $49 billion toward extending unemployment benefits, while the rest of the money in the proposal is allocated toward programs such as the “jobs tax credit” for the long-term unemployed.

The payroll tax cuts for employers will reduce the cost to employers of hiring labor. This reduction in cost of hiring labor can, in turn, be expected to increase demand for labor, thereby encouraging employers to hire new workers or increase pay to current employees.

Also, by cutting the employer’s share of payroll taxes, employers will have more money to invest into growing their business. Of course, increased investment would boost aggregate demand, thereby boosting short-term economic growth. More importantly, however, is that increased investment would boost economic growth in the long run, thereby providing us with higher living standards years down the road.

The payroll tax cuts for employees will put more money in the pockets of the average person, thereby encouraging them to spend their money on consumption goods or to save/invest their money. Either of these options will boost aggregate demand, thereby increasing economic growth. Households could use the tax cut to pay down debt, which might not stimulate economic growth immediately, but by deleveraging and cleaning up household balance sheets, this could encourage economic growth in the long-run. Thus, the payroll tax cut for employees will ease any hardships that working families might be facing while stimulating economic growth.

However, there are several problems with the President’s proposal.

First of all, extending unemployment benefits is contrary to the President’s stated goal of stimulating job creation and economic growth. Extending unemployment benefits simply encourages the unemployed to remain unemployed – why work when you’re being paid not to?

Secondly, the federal government is in a precarious situation when it comes to its debt-to-GDP ratio, which is now pushing 100%, so it would not be a wise idea to pass this stimulus bill without some concrete proposals about how to reduce national debt in future years. The President is proposing to pay for the “American Jobs Act” at least partially by raising taxes. Though this is one way to pay for the jobs bill, it may not be the best way - a study coauthored by Christina Romer, who was the former head of the Council of Economic Advisors under President Obama, shows that increasing taxes by 1% of GDP for deficit reduction purposes leads to a 3% reduction in GDP. So the President’s proposal goes about paying for his stimulus bill the wrong way.

Thirdly and lastly, while paying state and local governments to keep teachers and first responders employed might make sense from an aggregate demand point of view, it is important to note that in effect it bails out state and local governments which spent profligately during good economic times. It would be better to allow those governments to suffer the consequences of their fiscal irresponsibility, in order to encourage fiscal prudence in future years.

Overall, I think that the President’s job plan does more harm than good due to the fact that a significant portion of the plan is allocated towards extending unemployment benefits and implicitly bailing out state and local governments.

Leaving the unemployment benefits and government-bailouts aside, there are better ways to utilize the approximately $450 billion in the jobs bill. Given the stated goal of stimulating job creation and economic growth, it would make sense to focus most if not all of the bill toward cutting the employer’s share of payroll taxes. This would immediately increase the demand for labor, thereby alleviating unemployment directly. This, in turn, would boost consumer demand, thereby further boosting the economy in the short-run. Moreover, as noted before, cutting the employer’s share of payroll taxes would leave more money in the hands of employers, thereby encouraging investment, which would boost long-term economic growth.

Furthermore, there are better ways of paying for this bill and reducing the deficit than raising taxes, as President Obama has proposed. The single best way to go about reducing the deficit would be to reduce transfer payments, which have no net impact on aggregate demand, such as Social Security and unemployment benefits. We could go about doing this by means-testing these programs and gradually reforming them to include personal accounts or, better yet, phasing these programs out over the long term.

Works Cited

"Obama's Job Speech: A Call to Action." The Economist. 9 Sept. 2011. Web. 25 Sept. 2011.

Romer, Christina, and David Romer. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks." American Economic Review (2010). Web.

Tax Cuts Can Improve U.S. Credit Rating

Yesterday, S&P downgraded U.S. government debt from AAA to AA+. This move has been precipitated by Egan-Jones, an independent credit-rating agency which downgraded US debt in July.

So why did the US debt get downgraded?

Well, Egan-Jones downgraded US debt because of an increasingly unfavorable debt-to-GDP ratio. The downgrade probably would not have occurred had the US government made some credible plan to cut spending, balance the budget, and reduce the debt while pursuing pro-growth policies.

S&P downgraded the US debt for basically the same reasons. You can read those reasons here. You can listen to David Beers, a top dog at S&P, explain their decision here. To summarize, their reasons are the following:

1. The US government didn't cut the deficit enough over a 10-year period in the recent debt ceiling showdown.

2. There's political uncertainty as to whether the US government will be able to cut the deficit/debt enough, due to the Republican's unwillingness to raise taxes and the Democrat's unwillingness to cut spending, especially entitlement spending.

3. The debt-to-GDP ratio is too high.

4. The prospects for US economic growth remain weak and the US couldn't possibly "grow" its way out of its debt problem.

Of course, there's huge controversy over this debt downgrade. The White House is claiming that the S&P made a serious math error that led them to this downgrade... Which is a downright laughable claim, assuming that all of the fundamental reasons why the debt was downgraded are still there: high debt-to-GDP, poor political environment mainly due to strong political uncertainty, and weak economic growth.

And, obviously, political mudslinging is going on over this. Republicans, the Tea Party, and others are blaming the left and establishment Republicans for spending like drunken sailors under Bush and Obama. Federal spending, after all, has more than doubled since 1999. Democrats and the left-wing media (including the supposedly "independent" Anderson Cooper of CNN) are blaming the Republicans for not agreeing to taxes on "the rich," "Big Oil," and "Big Corporations."

Well then, allow me to completely disprove that notion. In fact, allow me to show how CUTTING taxes would have created a better economic outlook and more tax revenues over the long-run, and how such a move could possibly have avoided a downgrade of the US debt.

This study shows that a cut in the US corporate tax rate of 10 percent would increase economic growth by 1.1%. The average US corporate tax is roughly 35% (the highest tax bracket is 39% though). So an elimination of the US corporate income tax would increase economic growth by about 3.85% per year. See where I'm going with this? The US economy is more-or-less $14.6 trillion large. Assuming no other economic growth, an elimination of the corporate tax rate would grow the US economy by $562bn in one year and from $14.6 trillion to $21.3 trillion in ten years. That's a total increase of $6.7 trillion or 45.89%. In twenty years, no corporate tax rate would grow the US economy from $14.6 trillion to $31.1 trillion, for a total increase of $16.5 trillion or 113%.

Now, in 2009, the US government collected $339.3bn in tax revenues from the corporate income tax. I'm not quite sure what the figure is for 2011, but I'll eyeball it and say it's $350bn, which will more than allow for the very weak economic growth that has occurred between 2009 and now. Over ten years, not having this tax would result in $3.5 trillion in lost tax revenues. Over twenty, it would result in $7 trillion in lost tax revenues.

Now, remember that a major reason why the US government's debt was downgraded was that the debt-to-GDP ratio was too large. What we see above is that eliminating the corporate tax rate would increase government debt by $350bn in one year, $3.5 trillion in ten years, and $7 trillion in twenty years. HOWEVER, we also see that eliminating the corporate tax would increase the size of the economy by $562bn in one year, $6.7 trillion in ten years, and $16.5 trillion in twenty years. Thus, eliminating the corporate income tax would result in a loss of revenue (at least over the near term), but the resultant increase in economic growth would offset that revenue loss and actually reduce the debt-to-GDP ratio, thus placing the US government on a better financial footing.

And this isn't only true regarding corporate taxes. Studies conducted by the Harvard economist Robert Barro have shown that tax cuts have a multiplier greater than 1.0. Basically, what this means is that each dollar cut in taxes (and thus added to the debt) creates more than one dollar in economic growth, thus decreasing the debt-to-GDP ratio. Barro's studies have also shown that spending increases have a multiplier less than 1.0, meaning that each dollar increase in spending creates less than $1 in economic growth, therefore increasing the debt-to-GDP ratio.

Barro's studies have also been backed up by studies conducted by two other Harvard economists, Silvia Ardagna and Alberto Alesina. These studies are even more important for our purposes here, as they not only show that tax cuts have a positive effect on economic growth, but that spending cuts are a better tool for reducing deficit spending than tax increases.

But wait! There's more! There's also the fact that, in the very long-run, tax cuts will not only reduce debt-to-GDP, but also increase overall tax revenues.

Going back to our corporate income tax example, an elimination of the corporate tax would result in a revenue loss of $350bn per year or $3.5 trillion every ten years. But that doesn't account for two things: (1) How increased economic growth from eliminating corporate taxes will increase revenues from other taxes; and (2) How some of the lost revenue from eliminating the corporate income tax will be regained through other taxes (e.g. eliminating the corporate tax will inevitably increase capital gains, thus increase tax revenues from the capital gains tax).

Unfortunately, this second factor cannot be readily quantified for - I've seen estimates everywhere from 50% to 100% of lost tax revenue from corporate income taxes would be recouped through other taxes. Because we cannot quantify this number, I do not think it's fair to use it in our analysis.

However, we can do rough "back of the napkin" calculations to determine how much increased economic growth will increase tax revenues. Again, going back to the 2009 figures posted above, the federal government collected $2,331.6 billion or $2.3 trillion in all tax revenues minus corporate tax revenues. Since, in our analysis above, we increased 2009 corporate tax revenues by about 3% to account for the minimal economic growth that has occurred between 2009-2011, we'll also increase the revenues from other taxes by 3%, which puts those revenues at $2.4 trillion.

When we account for the increase in economic growth over ten years from eliminating the corporate income tax, I think it is totally fair to assume that tax revenues from other taxes will increase by the same amount as the size of the economy. After all, tax revenue is proportionate to national income, especially since the majority of tax revenue in the United States come from taxes which tax incomes (e.g. individual, payroll, and capital gains taxes). So taking this assumption into account, tax revenue from other taxes would increase from $2.4 trillion to $3.5 trillion in ten years; from $2.4 trillion to $5.11 trillion in twenty years, and so on.

Of course, because the elimination of the corporate income tax would mean would reduce revenues by $3.5 trillion every ten years, these tax cuts wouldn't pay off in the first ten or twenty years. But when I did a little more math, I discovered that they would pay off between 60-70 years, as tax revenues would increase to $23.15 trillion in 60 years and $33.78 trillion in 70 years... Which would more than pay off the $3.5 trillion loss every ten years. (You do the math: $3.5 trillion x 7 decades = $24.5 trillion in lost revenue, while an increase from $2.4 trillion in tax revenues to $33.78 trillion means an increase of $31.38 trillion, which more than makes up for the $24.5 trillion loss.)

The above analysis can also be used to determine how long it would take other tax cuts to pay off.

So how's that for a debunking of left-wing rhetoric? Three Harvard economists have conclusively shown that tax cuts reduce debt-to-GDP while spending cuts are a better method for balancing the budget than tax hikes. I've also shown how corporate income tax cuts boost economic growth, reduce debt-to-GDP, and eventually pay off in the form of overall higher tax revenues.

So, next time you hear someone say it's time to tax the rich more, you know how to answer.